Two-Faced

They Go High You Go Low

Soundbite: The broad stock indices hit new records last week with a twist, as 28 stocks in the S&P 500 hit 52-week lows, and 70 stocks hit one-month lows. OK, out of 500 stocks, that probably happens all the time, right? Wrong. When the Index registers a record high, that many equities experiencing a sharp selloff is a massive negative divergence. This alters the upside risk-return profile and carries an important message for bulls to temper expectations. Just as investors are settling in for an extended run, this is the time to be on high alert.

Scanning a century of history, last week’s imbalance has only appeared three times before: December 1999, January 1973, and July 1929 (h/t Jason Goepfert). Reflexively, higher prices from the excitement over the internet in 1999, computers in 1973, and radio and automobiles in 1929 convinced investors to expect permanent and endless profitability. During those three periods, as is the case today, leaders streaked higher, but laggards not only underperformed, they moved in the opposite direction. Durable uptrends are broad-based, with clusters of stocks making new 52-week highs together, so when 52-week highs and lows occur simultaneously, it is a red flag. When 5% of stocks make new lows during an uptrend, especially at new highs, that is a signal for an unstable equilibrium. Pave’s risk measures have been rising in recent weeks, warning of higher volatility and downside air pockets from any negative news.

In the three previous scenarios, stocks still had 5%-10% upside before vicious selloffs, so bulls may be right in their optimistic forecast. However, it is not too early to search for hedges.

For example, 10-year Treasury yields are nearly one percentage point higher than the S&P 500 earnings yield. The time to be wildly optimistic about stocks is when no one else is. Those entry points arise when equity earnings yields are 4-6% above Treasuries to compensate for their added risk and heightened volatility, not -1% as they are today. Because we anticipate higher inflation, it is important to strategically manage fixed income exposure, especially exercising caution with corporate bonds. Corporates are fully valued given their tight spreads to Treasuries and impending supply from hyperscalers intent on financing data center buildouts. However, higher bond allocations that include Mortgage-Backed Securities and Municipals are looking more attractive if managed actively.

Treasuries can be considered cheap relative to stocks even as record index highs mask the underlying weakness beneath the surface. Again, history warns that additional highs can be fleeting. Warren Buffett’s warning last week that we are living in a casino is a corroborating voice of reason.

Fed Loan Officer Survey: Jekyll and Hyde

Soundbite: Banks’ willingness to lend is sandwiched between the positive impact of reduced government oversight and concerns over potential default risk from concentrated exposure to software in Nondepository Financial Institutions’ (NDFI) portfolios. Meanwhile, banks continue to face pressure to lower underwriting standards due to the competitive presence of private credit firms. The Federal Reserve’s Senior Loan Officer Opinion Survey (SLOOS) for Q1 was conducted between March 23 through April 3, before the ceasefire improved the general outlook. Nevertheless, we still regard "Economic Uncertainty” as the primary driver behind tighter lending standards for Commercial and Industrial (C&I) loans. Loan officers grew more conservative despite improved corporate demand. Bank executives are feeling the squeeze from these willing private borrowers who are also competitors. The need to lend to them is tempered by the concern that the creditworthiness of NDFI portfolio companies are deteriorating.

This quarter’s Fed survey stands as a litmus test for banks’ views on the NDFI threat, as a special set of questions on private equity and credit was included. We have been concerned about the deterioration in bank lending portfolios if their underwriting discipline slips, yet banks feel compelled to ease them regardless. The most popular reason cited for easing credit standards to NDFIs was “More aggressive NDFI competition,” and notably, not a single bank mentioned less aggressive competition as a reason for tightening lending terms. The pressure is entirely one-directional.

Banks reported that private equity and credit customers increased loan demand this year, driven by “Increased liquidity needs.” Yet some lenders are feeling the tension behind expanding loans to the sector. Banks expect private equity and credit companies will be aggressively expanding their own portfolios this year, adding to the pressure for banks to do so as well. However, the more conservative banks are tightening credit standards, and their most important reason to do so was “increased borrower credit risk.”

We expect this conservative approach is the right way to go.

The major banks have lagged the S&P 500, as has every single sector other than technology. Therefore, we cannot attribute specific investor anxiety over the pressure banks face to lower their loan quality. Yet this report does raise our anxiety that banks are moving in that direction.

This is how credit cycles turn into a bubble. Banks can’t help themselves. For now, banks have not crossed any systemic risk threshold, provided private equity and credit portfolios remain stable. But we will pay close attention to the relative performance of bank stocks when any private credit default news hits. We may be approaching a tipping point.

Liberté, Égalité, Électricité

Soundbite: Investors were quick to overlay the 2022 analog as their base case with the assumption that Europe would be a casualty of the closure of the Strait of Hormuz. The connection is tenuous at best, however, because the continent learned their lesson four years ago and took action. Therefore, stagflation worries may be overblown in the region. This is not to downplay the probability of higher crude prices cascading into broad inflation globally. Still, excessive pessimism about Europe’s prospects may mislead investors on the Euro, ECB monetary policy, and the relative global performance of European equities. Bloomberg reports stable electricity prices, unlike the spike following the Ukrainian invasion. Four years ago, Europe was strangled by transmission bottlenecks, but it is no longer burdened by insufficient battery supply and aging infrastructure.

Since 2022, Europe has undergone a significant integration of renewable energy sources and its electric grid has attracted billions in new investments. Both factors are helping the service sector cap prices, at least so far. This could prevent a replay of 2022, when small and medium-sized companies raised prices to counter energy costs. Eurozone stocks underperformed the S&P 500 during the American Exceptionalism surge but reversed in 2025. Capital moved into Europe on expectations that increased European fiscal budgets for defense and infrastructure spending would fuel a positive output gap. Since the Iranian conflict, the EZU (MSCI Europe ETF)-to-SPY ratio fell to one-year lows as markets priced in a European energy crunch. If those fears prove misplaced, and the 2022 analog does not repeat, European shares present compelling value.

The improvement has been supported by better natural gas supply dynamics, vastly improved nuclear and hydro-power production, and a solar industry revival. A look across the four main energy areas underlines the difference between then and now:

• Natural Gas: While supply has been constrained by reduced Qatari output, the price of gas has already fallen 40% from its March peak, which is also 85% below the 2022 peak. Today’s supply imbalance is far more modest and is supported by China reducing its own gas imports.
•  Nuclear: In 2021 and 2022, France’s nuclear industry was severely undersupplied, dragging down Germany as well given its reliance on French power. Nuclear capacity has more than doubled since then.
• Hydro: Surprisingly, hydro comprises almost 15% of the EUs electricity consumption. An exceptionally bad drought in 2022 caused a contraction that pushed supply to 20-year lows. Today, normalized weather conditions have helped restore this source.
• Solar: The sector has been a major recipient of capital outlays, alongside expanded battery storage. Bloomberg reports that solar output is “setting fresh records across multiple markets on the continent, sending short-term electricity prices below zero on many weekends.” With prices at 10-year lows, solar now costs a fraction of its 2022 levels.

Robust power grid investment across Europe adds to the improved supply picture, and an instance where it could be safe to assume that “it really is different this time.” Bloomberg points out that “German benchmark power prices are just 4% higher than their 2025 average. Compared with 2022, they’re down more than 90%.”

In our rankings, we are seeing improvement in European small caps; while we are not outright Europe bulls, the conditions are there for a move.

What to Look for This Week

(All times E.S.T.)

1. Tuesday, May 13 at 8:30 a.m. April Consumer Price Index. The April Inflation Nowcast from the Cleveland Fed forecasts a 2.6% core annualized inflation rate, unchanged from March, and anticipates a steady trend into May of 2.6% in core CPI. The forecast is not much of a stretch: since the October shutdown hiatus, November and December Core was also 2.6%, with January and February at 2.5%. There are some potential upside surprises: service inflation ran high in March (3% for shelter, 4.1% for transportation services, and 3.7% for medical care services). We will see if the 3.2% drop in volatile used cars and trucks rebounds and creates upward pressure.
2.  Wednesday, May 14 at 8:30 a.m. April Producer Price Index. Core PPI rose by 3.8% last month, level with February and the highest since January 2025’s 3.9% level. Our favored Producer Price statistic excludes Food, Energy, but also Trade Services. That reading is net of manufacturers’ profits, yielding what we perceive as the cleanest signal of underlying inflation. That series hit 3.6% in March, the highest level in almost three years. Core PPI ex-Trade Services was 3.1% in March 2021 and went to 7.1% in one year.
3. Tuesday, May 12 at  5:00 a.m. Germany’s ZEW Indicator of Economic Sentiment for May. Sentiment hit a four-year low in April, dropping far more than expected, adding to March’s decline that was the third-largest monthly drop in the indicator’s history. But we are wondering if fears of long-term energy shortages dampening investment and undermining government stimulus are going to play out. European electricity prices have not risen, and we wonder if the grid upgrades since the Ukrainian invasion plus changes in solar, nuclear, and hydropower represent structural changes. If that is the case, we will see it reflected in this number, either in May or June.

FOMC Voters Speaking: Tuesday, May 12 at 3:15 a.m. John Williams speaks on monetary policy panel. Tuesday, May 12 at 11:00 a.m. New York Fed Quarterly Report on Household Debt and Credit. Wednesday, May 13 at 1:15 p.m. Minneapolis Federal Reserve President Neel Kashkari speaks in a moderated discussion. Thursday, May 14 at 1:00 p.m. Cleveland Federal Reserve President Beth Hammack speaks. We will be looking for any more follow-through to Kashkari and Hammack dissents from the April FOMC. Also on May 14 after market: 5:30 p.m. Governor Michael Barr on Fed Balance Sheet, and at 5:45 p.m. New York Fed President John Williams speaks in a moderated discussion.

Earnings: Monday, May 11 after market Petróleo Brasileiro S.A. – Petrobras (PBR) reports and we will look for Strait of Hormuz comments. Tuesday, May 12 before market, two Chinese ADRs JD.com, Inc. (JD) and Tencent Music Entertainment Group (TME) report. There have been troubling reports about the Chinese consumer’s poor position taking yet another downturn; we will see if that is confirmed. Wednesday, May 13 before market, Chinese ADR Alibaba Group Holding Limited (BABA) reports, and we will look for any insight into their Open-Source AI QWEN models. After market on Wednesday, May 13 Cisco Systems, Inc. (CSCO) reports after finishing their first monthly close above the previous all-time high registered in March 2000. Thursday, May 15 after market: Applied Materials, Inc. (AMAT) and Figma, Inc. (FIG). Looking at AMAT for comments on data center demand and FIG for the threat, or lack thereof, posed by Claude Design to their core business.

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By Peter Corey

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