Technical Bounce Follows Inflation Data

Last week, we were discussing various year-start indicators (or omens) and speculating on weather the recent bout of volatility represents a more concerning development or a buying opportunity. Overall, our conclusion was “it depends on one’s previous positioning”.

Now, it bears repeating that the first 5 days of January were positive and this particular indicator paints a bullish picture for 2025. However, the market immediately stumbled and tested support at the 100-DMA.

At last week’s close (Jan 10), almost all factors were displaying negative short and medium term MACD Signals, as well as averaging a dismal reading on the Overbought / Oversold indicator - just 11.6 / 100. With the exception of Growth Stocks (IVW) and the Nasdaq (QQQ), everything was technically down in the dumps.

Wednesday marked a turning point for the market, as inflation data was released. Notably, bond yields have surged sharply higher over the past couple of weeks, over fears of a resurgence of inflation and tariffs under the Trump Administration. Hotter than expected economic data didn’t help either. Our read was that the market had correctly priced in all of the valid concerns and overstated some of the risks. Any “not too bad” news on the inflation front would boost risk assets, and that’s exactly how it turned out.

CPI headline data aligned with expectations, rising 0.4%, with core CPI came in at just 0.2%. Here is a breakdown of the CPI report over the last five months:

Housing (the most significant contributor to the index) has declined over the last two months, as did healthcare. Food and Apparel did show some modest increases, but that is unsurprising given the holiday season. Holiday travel and replacement vehicles from North Carolina and Florida floods also did play a role in December’s inflation data for these categories, but these are temporary anomalies more likely.

All in all, inflation looks well contained, if a bit “sticky”. The so called “Sticky CPI” itself (as defined by the Atlanta Fed) is also showing a continued trend lower, with a slightly less pronounced rate of change in recent months. Our expectation is for the economy to experience slightly higher inflation for longer, but the destination (2%) is certainly achievable in the not too distant future.

In any case, given that inflation is never actually “stable”, a sharper decline due to economic weakness is a far more likely outcome than a strong advance or a “new paradigm” scenario.

We’ve already seen some notable declines in wages growth (Average Hourly Earnings stand at 3.9% and have “underperformed” inflation) - as well as a continuous trend lower of Job Quits. The stabilization of the labour market will eventually feed into inflation dynamics, as the growth rate of the Personal Consumption Expenditures Index (PCE) will have no way to re-accelerate.

All in all, the data was received in an optimistic manner, especially by an oversold market. Growth / Tech oriented factors (IVW, QQQ, MTUM) vastly outperformed, but so did small-caps (IWM). We attribute the strength in small caps to the fall in yields, as these stocks are more likely to be impacted by higher rates. By the end of the week, 8 / 10 factors had achieved a positive MACD crossover in the short term.

The market (SPY) broke above both the 20 and the 50-DMA by the end of the week. The way is now cleared to test resistance at $606-$610. A breakout rally above $610 will most likely cause algos and market makers to start “chasing”, as a squeeze is most likely to occur. Until then, we remain in “mean reversion mode, with some extra technical support by the way of the 50-DMA at $595.

With sentiment now back to “Neutral”, it sure seems like the “worst” is behind us. There is certainly enough bullish impetus to carry the rally forward this week as well, especially with more earnings data coming out and companies restarting their share buyback programs (we’ve been in a blackout period during the past few weeks, so the weakness was not that surprising).

Our Trading Strategy

We will continue to manage risk accordingly, but the near-term correction since the beginning of the year is likely over for now. As we said during the last 2 newsletters, it was important to maintain a level headed approach during this period. On our real-life client accounts, we have both added to risk exposure where needed as well as removed exposure from excess allocations. In other words, we’ve rebalanced to “Neutral”.

During 2025, maintaining this balance will be crucial. Investing will require discipline, as well as a blend of optimism and caution. Given the slowdown in economic growth, uncertainties surrounding fiscal policy, global challenges, overinflated sentiment, and high earnings expectations, investors have numerous reasons to proceed carefully. A moment will arise to significantly increase cash reserves. That moment is not now, but our portfolio management strategies are designed to reduce exposure when the selling really begins.

Meanwhile, it is equally crucial to capitalize on bullish trends while they persist. Sometimes offence is also the best defence.

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