"Good news is bad news"! Citigroup: The focus of the U.S. stock earnings season is on macro data

Earnings season usually makes the market more focused on micro issues. However, the upcoming Federal Reserve meeting, Trump's "100-day new policy," and the unusual backdrop between economic data readings and stock market reactions are all worth investors' examination of the short-term macro correlation with the S&P 500 index.

Citi released a research report indicating that currently, the U.S. stock market is in an environment where good (macro) news equates to bad (stock market) news, a situation that may persist until the first quarter. More negative interest rate correlation, especially real interest rates, and the inverted breakeven relationship are key driving factors of this mechanism. From the perspective of cross-asset volatility, the connection with the dollar is also more negative than usual, which may be the most significantly policy-affected macroeconomic factor.

Citi stated that during this earnings season, macroeconomic factors may be more important. The market typically shifts its focus to company performance during earnings season; however, this year, Trump's inauguration and the Federal Reserve meeting have disrupted the typical news cycle. This draws our attention to the macro impact on the S&P 500 index, even as earnings and performance guidance are gradually released. Citi pointed out that the U.S. stock market is currently still in a "bad macro = good stock market" mode.

The mechanism of good (macro) news equating to bad (stock market) news is not uncommon. However, the extent to which the Citi Economic Surprise Index's correlation with the S&P 500 index has turned negative, as well as the duration of this relationship, is noteworthy. Based on historical and current valuation/sentiment backgrounds, Citi believes this situation may persist for most of the first quarter.

The rising correlation between stock market increases and declining interest rates is a result of more negative correlations with real interest rates, coupled with the breakeven inflation correlation turning negative. Among the 2-year, 5-year, and 10-year segments of the U.S. Treasury yield curve, the 10-year Treasury yield currently has the greatest impact on stock market trends. Relatedly, a flattening of the short-term curve may also be beneficial for stock indices, particularly the key segments between the 3-month and 10-year yields.

Citi pointed out that tariff negotiations are affecting the dollar. The dollar has clearly been responding to the changing tariff risks posed by the new U.S. government, with increasing concerns about the trade war reflected in the appreciation of the dollar and related safe-haven stock market price actions, and vice versa. This explains the recently observed phenomenon of a more negative correlation between stocks and the dollar.

Citi also noted that the decline in oil, interest rates, and implied volatility of the dollar typically supports stock risk. Recently, the correlation between the S&P 500 index and the implied volatility of oil and interest rates has approached zero. The degree of negative correlation with foreign exchange implied volatility has weakened but remains greater than the correlation with other cross-asset volatilities.

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"Good news is still bad news"

Is positive economic news beneficial for the U.S. stock market? Citigroup believes so in the long run. Although the relationship between GDP and earnings growth has weakened over the past few decades, there remains a positive connection between macroeconomic factors and fundamentals.

However, positive macroeconomic news has led to bad news regarding inflation. In Citigroup's weekly pulse monitoring, they track the 63-day rolling correlation between the Citigroup U.S. Economic Surprise Index (CESI) and the S&P 500 Index. This correlation has been below zero since early December last year and is expected to continue declining into 2025.

Historically, this pattern of good news being bad news tends to be short-lived. However, given the depth of the current correlation, along with high valuations and sentiment starting points, Citigroup believes this situation may persist for much of the first quarter. Citigroup points out that a key driver is the stock market's response to interest rates. In Citigroup's analysis of 20 different macro connections with the S&P 500's performance, interest rates stand out. The 21-day rolling correlation with key points on the curve shows a more negative correlation than typically observed post-pandemic. This is driven by negative real interest rate correlations and the relationship with inflation breakevens, which have fallen below zero.

Another macro factor that has caught Citigroup's attention is the U.S. dollar, as it reacts to tariff negotiations. The relationship between the dollar's movements and the stock market has recently become more negative, as tariff risks are seen as unfavorable to the stock market fundamentals in the short term while supporting a stronger dollar. Additionally, compared to implied volatility of the dollar or oil, the S&P 500's performance seems more correlated with changes in the dollar's implied volatility.

Citigroup believes that combining this with the ongoing market narrative, the constantly changing short-term macro correlations indicate that the market is digesting the positive fundamentals for the stock market, along with economic normalization accompanied by low interest rates, inflation, and a weakening dollar; this aligns with higher implicit growth expectations, being in the traditional valuation high decile, and Citigroup's optimistic sentiment.

In the long run, good news on the economic front, especially unexpected economic upside news, is usually good for the stock market. However, this has not been the case since the correlation between the S&P 500's price movements and CESI turned negative in early December last year. Since then, the 63-day correlation between these indicators has continued to decline, even the higher frequency 21-day correlation is typically below zero