Deutsche Bank said the S&P 500 has seen only limited follow-through after last week’s interim US-Iran deal, even as oil prices fell and market-based stagflation concerns eased. The index remains below its early-June record, while credit spreads have widened over the same period and other gauges of financial stress have edged higher. Against that backdrop, the bank points to tighter financial conditions as a counterweight, with higher US real yields and a more hawkish Federal Reserve tempering any macro relief.
The bank also flagged that the market entered June with little spare capacity for further gains after a 16% rise over April and May. It described that two-month advance as an outcome seen only four other times since WWII, and added that three of those instances followed recessions, leaving just one non-recession example before the 1987 Black Monday crash. On valuation, it said the S&P 500’s CAPE ratio has climbed to its highest level since 2000, when the dotcom bubble was bursting, while the broader picture of economic resiliency has remained intact as data continued to surprise to the upside.
Limited Upside After Rapid Gains
We see the market struggling to digest recent good news. Despite WTI crude oil dropping to nearly $82 a barrel following the interim US-Iran agreement, the S&P 500 has failed to reclaim its early June high of 6,100. This suggests significant resistance is capping any further rally for now.
After a historic 16% surge in April and May, we believe there isn’t much room left for the market to run. With the Shiller CAPE ratio recently touching 38, a level not seen since the dot-com era, valuations appear stretched. This historical context makes us cautious about significant further upside in the coming weeks.
The Federal Reserve’s hawkish stance is the primary headwind, especially after last week’s CPI report came in at 3.1%. As a result, measures of market stress are ticking up, with the VIX climbing from a low of 14 to a more alert 18 over the past few weeks. This environment of heightened uncertainty and elevated volatility favors strategies that profit from time decay.
Strategies For A Range-Bound Market
Given the capped upside and resilient economic floor, we are looking at strategies that benefit from a range-bound market. Selling out-of-the-money call spreads on the SPX or establishing iron condors seems prudent. These positions allow us to collect premium while defining our risk, capitalizing on the expectation that the index will not make a major breakout move.
While the strong economy prevents us from expecting a major selloff, complacency is a risk. We are layering in some downside protection by buying put spreads with expirations in late July or August. This provides a cost-effective hedge against any unexpected negative shocks without being an outright bearish bet on the market.
