Deutsche Bank’s Henry Allen notes that despite the US-Iran interim deal and lower Oil prices, the S&P 500 remains below its early-June record and credit spreads have widened. He argues that a prior 16% two-month rally left valuations stretched, while higher US real yields and a more hawkish Fed have offset the macro relief, capping further gains in US equities.

Hawkish Fed and stretched valuations

"Last week’s interim US-Iran deal was a key moment for markets. But despite a considerable fall in oil prices, with stagflation fears easing considerably, risk assets haven’t benefited much. Indeed, the S&P 500 is still beneath its record high at the start of the month, credit spreads have also widened in that time, and other measures of financial stress have ticked up as well."

"Over April and May, there was a genuinely historic rally for many risk assets. Most notably, the S&P 500 was up +16% in a two-month period, something we’ve only seen on four other occasions since WWII. Moreover, three of those were post-recession bouncebacks, so it’s only happened once in a non-recession context, which was a few months before the Black Monday crash in 1987."

"Given we’d seen such a big rally that had stretched traditional valuation metrics, there simply wasn’t much space to rally further to start with. Indeed, this month has seen the CAPE ratio for the S&P 500 reach its highest level since 2000, around the time that the dotcom bubble was bursting."

"Finally, the underlying picture of economic resiliency is unchanged. Data has consistently surprised on the upside, and we’ve not seen the wider macro deterioration needed to generate bigger selloffs historically, whether that’s around an energy shock or generally."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)