/ April 22 / Weekly Preview
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Monday:
N/A
Tuesday:
S&P Global Composite PMI (52.2 expected)
Wednesday:
Durable Goods Orders MoM (2.5% exp)
Thursday:
GDP Growth Rate QoQ Adv (2.5% exp.)
Initial Jobless Claims (215K exp.)
Friday:
Core PCE Price Index MoM (0.3% exp.)
Personal Income MoM (0.5% exp.)
Personal Spending MoM (0.6% exp.)
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Monday:
Verizon Communications VZ
Zions Bancorp ZION
Cadence Design CDNS
Nucor NUE
SAP SAP
Tuesday:
Tesla TSLA
First Bancorp FBP
Freeport-McMoRan FCX
General Motors GM
Halliburton HAL
JetBlue Airways JBLU
Lockheed Martin LMT
NextEra Energy NEE
PepsiCo PEP
Philip Morris International PM
Quest Diagnostics DGX
RTX RTX
Sherwin-Williams SHW
Spotify SPOT
United Parcel Service UPS
Enphase Energy ENPH
Range Resources RRC
Visa V
Wednesday:
Meta Platforms META
AT&T T
Boeing BA
CME Group CME
General Dynamics GD
Humana HUM
Thermo Fisher Scientific TMO
Virtu Financial VIRT
Align Technology ALGN
Chipotle Mexican Grill CMG
Ford Motor F
Lam Research LRCX
O'Reilly Automotive ORLY
Raymond James RJF
ServiceNow NOW
Whirlpool WHR
Thursday:
Microsoft MSFT
Alphabet GOOGL
Atlassian TEAM
American Airlines AAL
AstraZeneca AZN
Caterpillar CAT
Grainger GWW
Harley-Davidson HOG
Merck MRK
Northrop Grumman NOC
S&P Global SPGI
Southwest Air LUV
Valero Energy VLO
DexCom DXCM
Edwards Lifesciences EW
Fair Isaac FICO
Gilead Sciences GILD
KLA KLAC
Roku ROKU
Western Digital WDC
Friday:
AbbVie ABBV
Chevron CVX
Exxon Mobil XOM
Piper Sandler PIPR
T. Rowe Price TROW
The Market Correction Continues
Since the beginning of April, we’ve discussed the increasing odds of a market correction to the tune of a 5%-10% drawdown. In our April 08 Weekly Preview, we wrote:
“we would expect a total drawdown episode of about 5%-10% to conclude before the November election […] It would also reverse a lot of the bullish enthusiasm currently embedded in investor psychology and feel much worse than it would actually be. 5%-10% corrections are absolutely normal in any given year, but bears will come out of the woodwork and doom & gloom headlines will dominate the news cycle.”
During the past week, selling pressure has been piled onto the equity market with little respite, confirming our bearish thesis. Investors have been spooked by a “reflation narrative” whereby the Fed will not be inclined to cut rates at all in 2024 as inflation re-accelerates. However, given the euphoric psychology of market participants, and very high technical deviations, profit taking was just a matter of time.
The week starts with SPY in a -5.35% drawdown from all-time-highs and sitting just below key resistance in the $503-$510 area. In the short term, the benchmark ETF is very oversold and we should normally get a bit of a bounce here. Any reflexive reversal would be a welcome opportunity to further reduce exposure, as our view is that this correction episode is not over yet. Ultimately, the buying opportunity we are targeting sits at $482 or below (-2.6% further losses).
The MACD signal’s downside extension has only been surpassed in a couple of instances in the past 2 years. Notably, this correction episode has been very orderly, with selling concentrated in the previous momentum names. This suggests that we are getting a “garden variety” drawdown, which is normal within a bullish trend.
According to BofA, the S&P 500 has experienced an average of three pullbacks of 5% or more every year since 1929. Whenever the first quarter of the year has recorded a more than 10% gain (as is the case in Q1 2024), the average maximum drawdown for the rest of the year has been -11%. In 10 out of 11 such years, the year has ended higher than the Q1 last close price. History suggests that any pullback is a buying opportunity in such cases.
However, the most pressing issue remains, for investors: is inflation here to stay?
Since the bullish rally started in early November, the rise in equity prices has been associated with a re-pricing of market rates. Specifically, Jerome Powell signaled 3 rate cuts at the December meeting and the market went as far as to price in 7 rate cuts for 2024. However, expectations for rate cuts have since dwindled to 1-2 cuts currently expected (or -0.4% worth of rate cuts).
In just the last month, the repricing has become very aggressive, as the inflation (measured by CPI) has increased to 3.5%, and core inflation held at 3.8%. As both of these measures remain above Jerome Powell’s target, the Fed as no pressure or incentive to do anything about rates at the moment:
“More recent data shows solid growth and continued strength in the labor market, but also a lack of further progress so far this year on returning to our 2% inflation goal. The recent data have clearly not given us greater confidence, and instead indicate that it’s likely to take longer than expected to achieve that confidence. That said, we think policy is well positioned to handle the risks that we face.” – Fed Chair Jerome Powell
Mr. Powell basically said “Higher for Longer”. The bond market immediately reacted and broke recent support, as TLT’s chart illustrates:
However, the recent uptick in inflation may as well be a result of higher commodity prices. Oil (USO) has rallied 22% since mid-December and it’s unsurprising to see a correlation between crude prices, inflation and interest rate expectations. After all, the price of oil has a knock-on effect on prices of manufacturing, delivery and actual consumption in the economy.
For now, the rally in commodities appears somewhat short lived and driven by geopolitics and speculation to a certain extent. In other words, economic fundamentals alone don’t fully justify the current price of oil. Eventually, the Fed’s monetary policy rates will cap economic activity, drag on economic growth and temper the gains of commodities.
Furthermore, CPI data is heavily skewed by delayed shelter calculations, which distort “live inflation” readings. Shelter accounts for 33% of CPI. In contrast to prices for bread, cell phones, and every other good and service (which use current prices) shelter CPI is based on surveys. In any given month, only 1/12 of total rents are re-negotiated (as contracts expire). Unlike the prices of other goods and services, the BLS effectively uses rent and imputed rental prices that are about six months stale on average. That 6 month lag looks like the chart below, with prices most likely headed lower in the near future.
Data from real estate company Redfin confirms the downward trend in asking prices for rent:
As CPI shelter eventually catches up to the realities of declining rent (6 months from now), we should see inflation start to decline again, especially if the rally in commodities relents. Then, we suspect, the Fed will get more dovish, more cuts will get priced in, and the market will rally again.
Our Trading Strategy
To sum up, we’ve seen the “perfect storm” of various factors at play, leading to this ongoing market correction:
High deviations and investor exuberance in the equity market, leaving markets vulnerable to profit taking
Inaccurate inflation readings coupled with a speculative commodity rally
A re-pricing of interest rate expectations
In the very short term, as markets are oversold, we would expect a bounce. This could be supported by a reaction to earnings in some of the most influential mega caps this week: TSLA reports on Tuesday, META on Wednesday, MSFT and GOOG on Thursday.
In case of a short term reflexive rally, we would be inclined to sell equity exposure when SPY is priced around $503 - $510. We would expect this reflexive rally to be short lived. The correction would most likely continue in the medium term and exceed -7.5% of drawdown.
Then, especially as commodity prices peak, we would rotate into aggressive (and hopefully beaten down) growth names for a continued rally into the end of the year. Bonds are also a BUY at these levels, but the high correlation to the equity market is unflattering for 60/40 portfolios. Gold and Commodities are nearing short term tops and we would be inclined to sell these on any further rally.
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