Weekly Preview / July 11
Notable Events on our Weekly Watchlist:
Monday: NA
Tuesday: Consumer Inflation Expectations
Wednesday: Inflation Rate, CPI
Earnings: DAL
Thursday: PPI, Jobless Claims
Earnings: JPM, MS
Friday: China GDP Growth, Retail Sales, Consumer Sentiment
Earnings: BLK, WFC, C
ETFs to watch: SPY, TLT
After a fair advance last week in equity markets, we are now entering another pivotal period, starting with the current week. Everything revolves around Wednesday’s inflation report (8.8% expected YoY and 5.8% expected for Core Inflation). Monday and Tuesday will most likely be used by traders to position ahead of the report, with the Inflation Expectations print offering clues about where the Fed policy must go. The July 27 Fed meeting currently has priced in the following odds: 93% of a 75bps rate hike and 7% of a 100bps rate hike. We will keep an eye on these odds as signs of a market psychology shift, but the Fed still seems to be playing catch-up to us. Following the announcement on Wednesday, Q2 earnings reports will begin to trickle in, starting with the financial sector. We’ll take a look at important markets below and see where all of this leaves us.
TLT Analysis
After initially surging on a soft inflation view, TLT got rejected at the 50-day DMA and has consolidated in a tight range. We have waited for a let-up in buying pressure to initiate, then add to this position. It looks to us as a promising setup, provided that inflation numbers don’t completely blow up to the upside on Wednesday. If we get a hotter than expected print, TLT will test lower support at 109.7 - and it is critical that it should hold. I expect further upside if inflation is tame, or at least comes in at expectations. In either case, treasuries certainly present a better investment opportunity than equities at this juncture, with a hefty amount of risks already priced in.
SPY Analysis
Equities, on the other hand, have managed to put in a respectable showing, and are slowly grinding their way higher in the short term technical channel. This year, rallies have been sold rather early. Portfolio managers have used bouts of optimism to reduce risks and raise cash. We don’t see this dynamic changing anytime soon, as by many technical measures, SPY is closer to resistance rather than support. We will clearly get a knee-jerk bid if inflation comes lower than expected, with the 410 level highlighted by our analysis. As stated in the monthly update, we will use that level to add some speculative short positions if we get there early. All signs point to an earnings recession, which will take some time to unfold as Q2 reporting gets underway. If inflation comes in hot… watch out below! For now, we are still neutral on equities (with the exception of the Energy sector).
Market Breadth Analysis
We are focusing on the Market Internals > Overbought/Oversold instrument as it has been the best at calling out significant pivot points in the market. On this front, we have witnessed a breakout of our technical range. Previous breakouts have signaled excellent opportunities to reduce exposure and add hedges. We’ll see if this is the case again.
XLE Analysis
We are continuing to focus on XLE in our Weekly Preview article because it is one of the only two sectors of the equity market with positive 6 month returns. XLE has bounced right off our isolated support level of 68.55, completing a technical retracement. It is now sitting at -0.4 standard deviations below the regression line, which has typically been a good place to buy on positive momentum. We would like to see XLE consolidate and hold at current levels before getting more aggressive. A deflationary recession could push commodities much lower (bullwhip effect) and take down the whole sector with the broad market.
Takeaway:
Equities have proven resilient once again, but big tests are coming up. The inflation report is critical, as is the forward guidance offered by company CEOs. A 100bps rate hike in July is now starting to be priced in, albeit with low odds. We like the safety provided by cash at this juncture. A wait and see approach is one that makes most sense right now, given the wide range of potential outcomes in all asset classes.
Andrei Sota