/ August 7 / Weekly Preview
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Monday:
N/A
Tuesday:
N/A
Wednesday:
N/A
Thursday:
Inflation Rate YoY (3.1% exp)
Core Inflation Rate YoY (4.8% exp)
Initial Jobless Claims (229K exp.)
Friday:
PPI MoM (0.2% exp)
Michigan Consumer Sentiment (71.3 exp.)
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Monday:
Palantir Technologies PLTR
Beyond Meat BYND
KKR KKR
Lucid Group LCID
Paramount Global PARA
Skyworks Solutions SWKS
Tyson Foods TSN
Tuesday:
United Parcel Service UPS
ADT ADT
Aramark ARMK
Bumble BMBL
Capri Holdings CPRI
Celsius CELH
Datadog DDOG
Eli Lilly LLY
Fox Corp FOXA
Invitae NVTA
Novavax NVAX
Perrigo PRGO
Rivian Automotive RIVN
Take-Two Interactive Software TTWO
Super Micro Computer SMCI
Twilio TWLO
Under Armour UAA
WeWork WE
Zoetis ZTS
Wednesday:
Disney DIS
Illumina ILMN
Jack In The Box JACK
Jazz Pharma JAZZ
LL Flooring Holdings LL
Nomad Foods NOMD
Roblox RBLX
The Trade Desk TTD
Wendy's WEN
Thursday:
Alibaba Group Holding BABA
Dillard's DDS
Hanesbrands HBI
Krispy Kreme DNUT
Ralph Lauren RL
Friday:
N/A
Debt Downgrade Triggers Correction
Last week, the US debt downgrade by Fitch Ratings made headlines around the world. Combined with a highly overbought market, it turned out to be the “surprise” catalyst to spark a more material downside move. We noted for several weeks already that the market is prone to this type of corrective behavior, for no reason other than its own overbought and extended condition:
“With sentiment amongst retail and professional investors sitting at “Extreme Greed” levels, we see a correction as more likely to occur than usual […] These conditions often align with short-term peaks in the market. Remaining patient and opportunistic with your allocation is likely to be rewarded, as there’s an increased chance we’ll get a better opportunity to “get on board”.
The screenshot below accompanied the quote above, making clear that sentiment had peaked. In retrospective, it is absolutely no surprise that we are currently getting a pullback.
Extreme Greed Sentiment, noted on July 24
On Friday, the S&P 500 rallied and failed at the 20-DMA. This technical failure puts lower levels of support as targets for the completion of the corrective process, since resistance has now been confirmed. A 3-5% correction is absolutely normal within any given year and should come as no surprise. Furthermore, a 10% correction to the 200-DMA is not out of the question and also entirely normal.
Given the bullish overall environment, momentum and sentiment, this currently remains a buying opportunity for agile investors and traders. While there are plenty of concerning fundamental factors at play, they won’t likely manifest until next year. Most importantly, the “shocking” downgrade echoed by media headlines will likely not impact the longer term market dynamics at all.
We explore SPY’s technicals in the chart below:
SPY Analysis
The MACD has signalled a SELL from an elevated level; previous correctionary processes have completed with the signal in the lower part of the chart;
The most logical target for the current downturn on SPY would be the R1 level ($431), roughly corresponding to a retracement to the 50-DMA. This would be enough to cool sentiment without causing a “panic”, and resolve the “Extreme Greed” levels recorded previously.
A more pronounced correction could take SPY down to the $410-$425 support area, where the upper trend-line and 200-DMA currently reside. Such a drop would certainly cause investors to pivot to “Extreme Fear” sentiment and we’ll start seeing bears come out of the woodwork. While it’s currently hard to “predict” odds for each scenario, these swings in sentiment to and from extremes have been commonplace in the past 2 years (5 swings to be exact), taking around 3 months to complete.
Taking seasonality into account, August and September are some of the weakest months for stock returns. It’s not unreasonable to assume, that given the previously overbought condition, markets will bottom by the end of September. While at this point, we are merely talking about history and technicals, let’s look into that debt downgrade a bit more carefully.
Debt Downgrade
On Tuesday, one of the three largest debt rating agencies, Fitch, downgraded the U.S. credit rating.
“Fitch Ratings has downgraded the United States of America’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘AA+’ from ‘AAA’. The Rating Watch Negative was removed and a Stable Outlook assigned. The Country Ceiling has been affirmed at ‘AAA’.
The reasoning provided by Fitch:
“The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.”
It is certainly true that since 2008, the U.S. has not passed a single budget. Congress has instead opted to “kick the can down the road” and use Continuing Resolutions, which are short term funding bills. These effectively raise the debt ceiling and increase spending by 8% annually. As a direct consequence, gross federal debt has grown unabated to 32$ Trillion.
The Congressional Budget Office has recently published a report for the Long Term Budget Outlook:
“In CBO’s projections, the deficit equals 5.8 percent of gross domestic product (GDP) in 2023, declines to 5.0 percent by 2027, and then grows in every year, reaching 10.0 percent of GDP in 2053. Over the past century, that level has been exceeded only during World War II and the coronavirus pandemic. The increase in the total deficit results from faster growth in spending than in revenues. The primary deficit, which excludes interest costs, equals 3.3 percent of GDP in both 2023 and 2053, but the total deficit is boosted by rising interest costs.”
Take note of that last part when analyzing the graph below.
Fitch also stressed this key issue:
“The General Government debt-to-GDP ratio is projected to rise over the forecast period, reaching 118.4% by 2025. The debt ratio is over two-and-a-half times higher than the ‘AAA’ median of 39.3% of GDP and ‘AA’ median of 44.7% of GDP. Fitch’s longer-term projections forecast additional debt/GDP rises, increasing the vulnerability of the U.S. fiscal position to future economic shocks.“
Our conclusion is that Fitch is correct in downgrading the debt of the United States. However, it may not matter as much as you think, at least not in the short term.
This is not the first time that U.S. debs has been downgraded.
“Credit rating agency Standard & Poor’s on Friday downgraded the United States’ credit rating, stripping the world’s largest economy of its prized AAA status […] The downgrade reflects our opinion that the … plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.” - August 05 2011
The issues flagged by S&P back in 2011, during the Obama administration, sound very similar to the remarks made by Fitch today. It all comes down to the government’s inability to deal with long term debt issues. However, Jamie Dimon, CEO of J.P. Morgan eloquently explains why a downgrade doesn’t matter:
“It doesn’t really matter that much” because it’s the market, not rating agencies, that determines borrowing costs. Still, it’s ridiculous that other countries have higher credit ratings than the U.S. when they depend on the stability created by the U.S. and its military. To have them be triple-A and not America is kind of ridiculous. It’s still the most prosperous nation on the planet, it’s the most secure nation on the planet.”
Jamie Dimon
Jamie is also correct. As long as the U.S. is essentially the guarantor of the developed world’s safety, its treasury bond market remains the world’s preferred “safe haven” asset, regardless of any rating.
So how did the stock market react in 2011, after the S&P downgrade? Let’s take a look at SPY’s chart from 2011 - 2012:
First off, in similar fashion to last week, the market was reasonably overbought to begin with. Then, headlines and fear mongers ramped up rhetoric about an immediate U.S. Dollar and stock market collapse. In the span of about 2 months, SPY corrected by roughly 17%. In retrospect, this turned out to be an excellent buying opportunity, as the bullish trend eventually resumed into 2012.
What about treasuries? Let’s take a look at TLT’s chart back then:
In a nasty surprise for many “bond gurus” who expected yields to spike (and treasuries to sink), the exact reverse happened. TLT soared 31% in the months after the downgrade.
Of course, the reality is that the economy cannot sustain higher for longer rates because of the $32 Trillion Debt Burden.
Our Trading Strategy
The long term implications of the debt situation is dire. The U.S. is showing all of the signs of an empire past its peak, with ever more erosion in terms of projecting its power across the globe. Internal power struggles, both on a practical and ideological plane, driven by income and wealth inequality, are taking a heavy toll on society and its ability to remain competitive against foreign powers. However, these “doom and gloom” projections take DECADES to manifest and are entirely reversible, if proper action is taken.
We are investing in the here and now. Our projection timeline is around 10 months into the future. And right now, U.S. Treasury debt is still considered the world’s only risk-free asset regardless of its ratings. Similar to 2011, the rating downgrade may provide an opportunity contrary to what headlines would have you believe.
Using Technical Analysis and Trade Signals, we are ready to embrace this opportunity as it presents itself. We are already planning to increase bond exposure in portfolios on the right signal, as well as equity risk exposure.
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