The S&P 500 fell 1.7% yesterday in a rout after strong service sector data triggered worries about inflation and further Fed hikes.
Scotia notes that the pain trade in stocks is higher for longer but they're not convinced we've seen peak inflation and peak Fed hawkishness.
They highlight three things to watch:
1) The VIX bottoming
They note that "the fear gauge dropped below 20 twice this year, and each time, it coincided with an exhaustion of the bear market rally (late March/April and August)."
2) Overheating conditions
Scotia highlights that 91% of S&P 500 stocks are trading above their 50-day moving average and that compares to 92% at the summer peak.
3) The Fed won't be convinced on jobs
The "rising probability of a 50 bp increase in December delights investors as if the Fed was done. Powell indicated several times that he wants to see a softening job market, but we have yet to see any evidence of a sustained slowdown." Scotia notes. "Cheering for a 50 bp increases clearly highlights some complacency among investors. As the old saying goes… be careful what you wish for."
Finally, they note that stocks still look less attractive relative to bonds with both climbing in November.
"We still believe the rally will fade, that the next few months promised to be volatile, and a more defensive posturing remains warranted, in our opinion. We believe opportunities on the long side will appear in the first half, providing a more appealing risk-reward proposition for equities," Scotia writes.
They have a year-end 2023 target for the S&P 500 at 3900, which is about 100 points below spot.