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

XLE Analysis

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