Ref Price: SPX 6740 , VIX 29.48

Acceleration (Growth ⬆, Inflation ⬆) is the current market regime. It is a risk-on environment, characterized by rising growth and inflation, supported by fiscal stimulus and infrastructure spending, while central banks often maintain accommodative policies, such as low interest rates or targeted stimulus, to sustain economic expansion. In an Acceleration regime, participants are generally optimistic about economic conditions. This often leads to capital rotation into cyclical sectors that benefit from rising demand and pricing power.

Due to the U.S.–Iran conflict and the resulting oil shock, inflation pressures are likely to continue rising, while growth is approaching our transitional threshold of 50. A break below this level would signal a shift in our model to a Tightening Regime.

Tightening (Growth ⬇, Inflation ⬆) is a risk-off regime with an inflationary bias, characterized by rising inflation and falling or stagnant growth. In a Tightening regime, participants become more cautious as rising prices erode purchasing power while growth declines. This often leads to capital rotation into lower beta defensive sectors and sometimes sectors that offer inflation protection, while growth and cyclical sectors tend to lag due to margin pressures and weaker guidance.

Growth Update: US economic data released last week painted a mixed picture for the growth outlook. Manufacturing held steady in modest expansion with the ISM PMI at 52.4 (above expectations but slightly down from prior), while services surged to a multi-year high of 56.1, signaling robust activity and supporting Q1 acceleration after Q4’s slowdown. However, the February jobs report delivered a major downside surprise, with nonfarm payrolls unexpectedly dropping by -92K (far worse than the ~50-60K consensus), the unemployment rate edging up to 4.4%, and weak retail sales in January (-0.92% MoM) pointing to softer consumer spending. Overall, resilient services and manufacturing provide some buffer, but the sharp labor market deterioration and subdued consumption have tempered optimism, raising concerns about slowing momentum and potential downside risks to near-term GDP growth.

*Bold highlights indicate material changes to the outlook since the last report.

The SPX experienced a bearish crossover, with the daily 20-day EMA (green) falling below the 40-day EMA (red). This follows last week’s breakdown in the High Beta–Low Beta signal into bearish territory. Additionally, the lower bound of the range at 6800–6770 was breached, with price closing outside the box that had contained price for months.

Growth Sectors: Since October 2025, Best Sector Now has identified signs that the AI-led surge is flattening amid elevated Technology and AI valuations and increasingly crowded positioning. Divergent market reactions to Q3 2025 earnings reinforce a shift toward greater selectivity, with participants rewarding disciplined capex while penalizing perceived excess. While crowded positioning alone does not signal an imminent downturn, it increases vulnerability to downside volatility should negative catalysts emerge.

Cyclical Sectors: With U.S. manufacturing returning to expansion in January 2026 after eleven consecutive months of contraction and our constructive outlook on growth intact, the rotation into cyclicals that began in December 2025 following the Fed’s introduction of RMOP remains supported. The improving manufacturing backdrop reinforces the case for continued leadership from economically sensitive sectors.

Defensive Sectors: Concurrently, inflows into defensive sectors suggest a measured recalibration of risk. Rather than indicating broad risk aversion, this positioning reflects selective beta reduction within portfolios, showing that market participants are balancing cyclical exposure with downside resilience.

As highlighted in our daily SRG (below) last week, we noted relative rotation out of cyclicals and defensives—some profit-taking after their strong run—and a shift into growth. This is precisely the kind of relative move we like to see on these dips: participants showing willingness to rotate back into growth names.

Our core view holds that growth sectors should lead the next meaningful leg higher, and this daily rotation stands as a constructive signal. That said, the bigger question remains whether the overcrowded growth trade has seen enough selling to attract renewed buying interest. We maintain that a real rebound in growth is unlikely without capitulation in Technology (XLK) or a meaningful cease-fire/de-escalation in the U.S.–Iran conflict. Now well into its second week, the war features intense U.S. and Israeli strikes on Iranian military, nuclear, and infrastructure targets, fierce regional retaliation, and no signs of de-escalation, with President Trump demanding unconditional surrender and Iran vowing to fight on. This has sharply elevated geopolitical risk, spiked market volatility, and severely disrupted flows through the Strait of Hormuz.

We continue to monitor energy markets closely for potential macro spillovers. With WTI crude now surging toward $100/bbl, this would sharply squeeze consumer spending, raise business input costs, pressure equities further, reinforce inflationary stickiness (potentially delaying Fed cuts), and impose a negative headwind on liquidity.

Our left-tail risk theme, Liquidity as a Binding Constraint, has been moderated by the Fed’s introduction of RMOP (see the theme Right-Tail Risk: Run It Hot). However, we remain concerned that this issue could resurface should strength in Oil and the Dollar persist.

Why is XLE not moving while oil is breaking out?
First, XLE did lead the move higher, and oil prices played catch up. Second, XLE’s muted performance amid the sharp oil price surge reflects the hedging strategies and integrated operations of its major holdings, like ExxonMobil and Chevron. These companies routinely hedge portions of their production to lock in prices, shielding near-term earnings from short-term volatility, while downstream refining margins often improve when crude spikes briefly. If the current geopolitically driven rally proves temporary, without prolonged supply disruptions or sustained outages, the bottom-line impact on these hedged majors remains limited. XLE’s subdued reaction, trading around $56 to $57 with only modest gains since oil’s explosive move, suggests the market is viewing this as a short-lived risk premium rather than the start of a multi-month oil shock that would broadly boost sector earnings.

4-Hour Oversold: XLB, XLP, XLV, XLI
4-Hour Overbought: None

*Bold highlights indicate material changes to the summary since the last report.

SPX GEX is currently -$780M, with price trading below below the 6800 Zero and 6830 Flip, reflecting a destabilizing backdrop.

The Put Wall has shifted lower to 6500, serving as our downside target as the worst-case scenario this week. On the downside, there is also a gap from 6630 to 6603. We are focusing on levels ending in 00 and 50, which act as key liquidity strikes and strong magnets in negative gamma.

Other key levels to watch include the 5% down market at 6652 and 6582 (200 DMA). We view the 5% down move as a logical downside target and potential bounce point. The trend is down, so any rally is most likely to be sold into.

The VIX remains very elevated and active, trading around 35 in the early premarket. Resistance is seen at large round numbers, particularly, 0’s and 5’s. The 50 level is a major threshold, followed by the 60 to 65 range, which marked SPX lows in April 2025 and August 2024.

Options are pricing in moves of 2% or more each day this week, with a 4.8% implied move over the next five trading days, implying a low of 6416 and a high of 7064.

The key to the upside is twofold: Oil down and VIX down. Together, these factors could trigger large and volatile squeeze rallies in the S&P 500. However, without meaningful de-escalation in the U.S.–Iran conflict, we see little reason for VIX to move significantly below 25.

The economic calendar, is highlighted by Wednesday’s February CPI report, with economists expecting headline and core inflation to rise at a 2.5% annual rate. On Friday, the Fed’s preferred gauge, core PCE, will be released alongside January income and spending data.

Markets will watch rate-cut odds for signs that higher energy costs could complicate the Fed’s path toward easing.

On the earnings calendar, Oracle (ORCL), Adobe (ADBE), Dollar General (DG), Ulta Beauty (ULTA), DICK’s Sporting Goods (DKS) and Lennar (LEN) are scheduled to report.

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