The broader market could test its highs given the propensity of stock to rally following an inversion of the yield curve, MKM partners says.
In three of the last four recessions, equities saw "powerful rallies" after the inversion but before a recession started, economist and strategist Michael Darda wrote in a note.
With the 10-year Treasury yield ( US10Y ) ( TBT ) ( TLT ) at 2.85% and the 2-year Treasury yield ( US2Y ) ( SHY ) at 3.19%, the 2s10s gap is at 34 basis points. The curve saw its biggest steepening in three months yesterday, but has been inverted for 29 days running, according to Deutsche Bank.
After the curve inverted in February 1989, "the S&P 500 ( SP500 ) ( NYSEARCA: SPY ) rallied 23.7% between then and the subsequent peak of the business cycle in July 1990," Darda said. "The curve also inverted in January of 2006, with the S&P 500 rallying 21.5% from that point until October 2007 when it peaked two months prior to the onset of the Great Recession."
"We also saw a nearly 15% S&P 500 advance after the yield curve inverted in the summer of 2019 until the peak in February 2020," he said. "We are not arguing that the market will make new highs this year (we are more in the trading range camp), but we would not be surprised to see a run toward the highs as inflation eases and the Fed slows the pace of rate hikes."
A 14% rally would take the S&P from current levels to its highs around 4,800.
Looking at the market now, MKM's sector-based equity-risk-premium model ranks Materials ( XLB ), Financials ( XLF ) and Healthcare ( XLV ) on top and Utilities ( XLU ), Consumer Discretionary ( XLY ) and Energy ( XLE ) at the bottom.
"Given our view of rising 2023 recession risks, we favor healthcare and GARP-based tech over some of the other more cyclical sectors," Darda said.
See why investors can expect the Fed to keep up the hawkish talk .
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Stock market can make a run for the highs - MKM