/ February 20 / Weekly Preview
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Monday:
N/A
Tuesday:
N/A
Wednesday:
FOMC Minutes
Thursday:
Initial Jobless Claims (220K exp.)
S&P Global Composite PMI (51.9 exp.)
Friday:
N/A
Building Permits (1.5M exp.)
Michigan Consumer Sentiment (79.5 exp.)
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Monday:
Tuesday:
Home Depot HD
Walmart WMT
Barclays BCS
Beyond, Inc. BYON
Chesapeake Energy CHK
Diamondback Energy FANG
JBT Corp JBT
Keysight Technologies KEYS
Medtronic MDT
Palo Alto Networks PANW
Teladoc TDOC
Westlake Corporation WLK
Wednesday:
Nvidia NVDA
Analog Devices ADI
DigitalOcean DOCN
Etsy ETSY
Garmin GRMN
Jack In The Box JACK
Lucid Group LCID
Marriott Vacations MVAC
Mosaic MOS
Range Resources RRC
Rivian Automotive RIVN
Suncor Energy SU
Wix.com WIX
Thursday:
Altair Engineering ALTR
Booking Holdings BKNG
Block SQ
Carvana CVNA
Cheniere Energy LNG
Dominion Energy D
Fiverr FVRR
Genco Shipping & Trading GNK
Intuit INTU
MercadoLibre MELI
Moderna MRNA
Oceaneering International OII
Pioneer Natural Resources PXD
Wayfair W
Friday:
Warner Bros. Discovery WBD
Inflation Threatens the Market
Last week, the unstoppable advance of the equity market drove the S&P 500 above the psychological 5.000 level. A disappointingly hot inflation report hit sentiment on Tuesday, provoking a -2.0% intra-day pullback. The market managed to recover all losses by Thursday, as details of the inflation report pointed to several statistical anomalies that did not warrant such a drop (we’ll analyze these later in the article as well). Friday ended on a weak note due to producer price inflation data, which was also disappointing.
Despite the eventful week, the S&P 500 only dropped -0.42%, with the Nasdaq registering a more meaningful loss (-1.46%). Small Caps (the Russell 2000) fared much better, rising by +0.50% over the last 5 trading days, in contrast to the large cap indices.
With momentum weakening and investor optimism quite high, SPY remains precariously overbought and prone to a more meaningful pullback or consolidation period (as suggested by seasonality, among other things). Support rises to $482 (at the R2 level and 50-DMA, implying a potential -3.5% downside move), while upside remains limited.
The loss of momentum is also evidenced by the negative MACD crossover that just triggered on Friday’s close. This short-term SELL signal argues for a period of sloppy price development, and also comes from a relatively high point - suggesting that downside risk is enhanced. Seasonality also does not bode well for the equity market according to AlmanacTrader:
“Mid-February has arrived and with it the probability of some market weakness in the near term is on the rise. February is the weak link in the Best Months and as we have pointed out on several occasions its average performance in election years, since 1950, has been tepid. As of yesterday’s close, NASDAQ was up 4.58% this February, S&P 500 was up 3.20% while DJIA was holding onto a 0.72% advance.
Compared to the recent 21-year average performance, S&P 500 and NASDAQ were well above average levels at this point in February while DJIA was modestly lagging. Based upon the following chart, typical second half of February weakness could begin any day now.”
When accounting for the US election in the seasonality equation, even more downside is suggested. Markets hate uncertainty, and the summer months pose a meaningful threat when the election outcome is uncertain (as it is now). The unknown element of post election policies and of the election process integrity in itself pose unique challenges this year.
Moreover, the performance of the S&P 500 year-to-date is also “too good to be true” when compared to seasonal averages.
While the bullish trend remains intact for now, the reality remains that excesses can only be resolved in one of 2 ways: either we get a sharp and significant pullback to a level of support ($466, -6.7%) or the market consolidates in a sideways formation through mid-June.
With the technical take out of the way, let’s take a look at the inflation data and what it means for Fed monetary policy.
A Closer Look at CPI Data
The inflation report published last Tuesday initially sent the market into a nosedive, as headline figures were hotter than expected:
Core inflation YoY was 3.9% vs expectations of 3.7%
Headline inflation YoY was 3.4% vs expectations of 3.1%
Let’s study the breakdown of CPI’s major components and their weight in the calculation:
Housing cost is the most significant contributor to CPI, accounting for over 30% of the weight in the headline data. This is also one of the most notoriously lagging variable, trailing real-time data by about 6 months. While actual rent tends to be more volatile, Owners’ Equivalent Rent is supposed to smooth the seasonal variations related to the “Rent of Primary Residence”. In any case, the observation here is that a notable divergence has occurred in an otherwise well correlated data set:
The change in Rent of Primary Residence has declined, while the change in Owner’s Equivalent Rent has increased. Since OER is used in calculating inflation, the curious discrepancy is skewing the CPI figures higher. The market caught wind of this, and bounced after the CPI data was released.
Notably, small and mid-cap equities have shown resilience in the past week, with both benchmark factors (IWM and MDY) managing to outperform. This is especially encouraging since small caps have been lagging badly for more than a year. The fact that IWM managed to hold above its pivot level at $200 puts our rotation thesis in play for the next couple of months.
While a notable divergence in market breath still exists, the internal deterioration in stocks trading above key moving averages looks to have stabilized.
Another important observation from the past week is the behavior of the treasury market. Bonds sold off as the possibility of a Fed rate cut gets projected farther and farther into the future. In January, markets were expecting the first rate cut to arrive as early as March. Now, interest rate traders are assigning a 53% probability of a cut in June, with barely 4 cuts in total for 2024.
TLT came under selling pressure and was unable to break above its 200-Day Moving Average and S2 level at $95. While clearly oversold, we need to see some more constructive price action before adding to this key position once again. We are of the opinion that, in the longer term, bonds offer a very attractive risk - reward opportunity.
If inflation and economic growth are going to slow, as the Federal Reserve intends, then yields will have no choice but to follow, sooner or later. As yields move inverse to bond prices, this is bullish for ETFs such as TLT and IEF.
Announcing a Quality of Life Improvement aiding Stock Discovery
We are rolling out an update across all tables in the platform that will allow you to click on a ticker and go directly to a “Snapshot View” that presents all of a stock’s essential data. This will allow you to quickly get familiar with names you are researching, and should come in handy for getting an overview. This will also work across our Articles and blog posts. Try it, by clicking on META for example.
Our Trading Strategy
The market is sending mixed signals. On one hand, mega caps have taken a breather in the past week, as their over-extended and overbought technical condition leaves many outperformers prone to profit-taking. The bulk of the market did well, as the main concern for small and mid caps is the avoidance of a recession in the U.S.
Last week, Japan and the United Kingdom reported a negative GDP for the second consecutive quarter, placing them in a technical recession. So far, the U.S. has managed to avoid the same fate, with fiscal stimulus and relatively strong credit-driven consumption keeping America afloat. If this continues, domestic small caps and value stocks (IVE) are well positioned to outperform. This is the crux of our rotation thesis, where the aim in portfolio management is to cut back on mega cap growth exposure (QQQ, NVDA, any kind of “Magnificent 7”) and add to small cap value or even energy plays.
Speaking of which, the main event driven catalyst for the week will be NVDA’s earnings release after the close on Wednesday. There will be a lot of talk about generative A.I. and the future, but our sneaky feeling is that all of it is well priced in, as the stock is trading at > $700. We’re ready to be proven wrong, but as the saying goes “nobody went broke from taking profits”. This phrase sums up our view for the overall market as well.
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