Weekly Preview / January 09
Notable Events on our Weekly Watchlist:
Monday: Consumer Inflation Expectations
Earnings: TLRY
Tuesday: Powell’s Speech
Earnings: BBBY
Wednesday: N/A
Earnings: N/A
Thursday: Inflation Rate
Earnings: TSM
Friday: Michigan Consumer Sentiment
Earnings: DAL, JPM, UNH, C, BAC, WFC
ETFs to watch: SPY, TLT
Yet another pivot rally sets up a tricky week to start 2023
The release of stronger than expected ADP Employment data led to a sell-off at the start of last week. Choppy trading conditions were the norm, with markets becoming rangebound and seeing successive 1.5% rallies and declines. Friday’s Non Farm Payrolls report sparked a surge in risk assets, as wage growth showed some weakness. The narrative behind the rally is the same as it has been for the past year: front-running the Fed’s pivot.
This sets us up for a very tricky week ahead, as technicals for the market have clearly improved, and short-term upside is available. Monday’s Consumer Inflation Expectations will provide some insight into how the psychological fight against inflation is going, and will be useful to watch. Tuesday, Powell will speak and will probably reiterate the same message - “no plans for a pivot in 2023”. He may already be aware of the inflation number that is going to be released on Thursday, the main market moving event of the week - again, something to pay attention to.
Friday marks the official start of Q4 reporting season, with JP Morgan, Citigroup, Wells Fargo and Delta Airlines on call. There will be plenty of action to keep track of, so let’s start by reviewing where we are:
SPY Analysis
The good news for the bulls is that SPY managed to break out of the recent consolidation range and is now set up to challenge the 200-day Moving Average ($398). The next major resistance level sits right above, at $402. With the MACD signal turning positive, and the price currently trading at the lower end of the Support-Resistance range, there is a decent chance of a further rally.
Sentiment is not nearly exuberant enough to make the argument that buyers are all in. Trend following algorithms will be net buyers on Monday, since they use Friday’s strong close as a signal. The short-term picture is clearly positive.
Issues start to present themselves when we start to account for the longer term, however. The main technical argument with a bearish tilt is Dollar Transaction Volume, which is deteriorating at a rapid clip (Market Internals / Volume). All of the price action from last week, when viewed through a Volume lens, seems less inspiring.
Volume is simply trending ever lower as the Fed removes liquidity from financial markets. As a consequence, we are still trading in an elevated volatility environment, with no signs of any kind of reversal. This is incompatible with ever-higher asset prices. If during QE it wasn’t a good idea to “fight the Fed”, it probably isn’t a good idea to do this now, during QT. Powell made it clear that “no pivot” is coming, yet financial markets are playing “chicken” with him.
“No participants anticipated that it would be appropriate to begin reducing the federal funds rate target in 2023. Participants generally observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2 percent, which was likely to take some time. In view of the persistent and unacceptably high level of inflation, several participants commented that historical experience cautioned against prematurely loosening monetary policy.”
The FOMC is concerned that inflation will re-accelerate if they loosen financial conditions too quickly (as it happened in the 70’s). What the Fed wants is a controlled “demolition” of asset prices (not a crash). We translate their language into the most probable path for SPY if their plan is achieved (-10% CAGR, taking SPY to $345 by year end).
Optimistic investors should be aware that the Fed is working toward lower asset prices (as they are a function of financial conditions). If the short term is clearly bullish, the medium and longer term path for risk assets faces serious headwinds from higher rates, QT, and a depletion of “stimulus” savings. Bulls are likely to be disappointed again and again by the Fed’s stance. QT caused a 20% drop in the market over a three-month period in the past, and it’s not ending anytime soon.
The coming recession that everyone knows about
“I keep being told this is the most widely anticipated recession ever, and it must already be priced in. But the decline in 12-month forward EPS of only 4% (from the peak) doesn’t suggest so.”
The S&P’s price drawdown is not reflected in a similar adjustment for EPS results by analysts.
However, the bullish outlook on the market may be problematic because as asset prices increase, financial conditions become more relaxed, which limits the Fed's ability to lower inflation. This may also lead to strong employment and wage growth, further driving up inflationary pressures. If and when the Fed will pivot, they will do so because SERIOUS damage has been done to the economy. The bar for a loosening of financial conditions is exceptionally high at this point.
Takeaway
We’ve seen this movie before (or so it seems). In the short term, bulls are in control of price dynamics, and the SPY has about 3-4% upside. In our view, this is a rally that should be sold into. As QT progresses and liquidity is removed, the market is poised to maintain a high-volatility profile, which will make trading ever more difficult.
That is why it’s more important to focus on the medium and longer term picture, and take advantage of any opportunities the short term might present us with. The longer term picture is bearish at this point. We will closely follow our automated models and adjust allocation to a more positive outlook if such a view is warranted. For now, our cash heavy and slightly net-short positioning is fine, even if it is prone to underperform in the case of a market rally.
Andrei Sota