Weekly Preview / June 13
Notable Events on our Weekly Watchlist:
Monday: NA
Tuesday:
NFIB Small Business Surveys, PPI
Wednesday:
FOMC, MBA Mortgage Applications, Empire Manufacturing, Retail Sales, NAHB Housing Index, Trade Prices
Thursday:
Building Permits, Housing Starts, Philly Fed Business Outlook Survey, Jobless Claims
Friday:
Industrial Production, Capacity Utilization, Mfg Production, Leading Index
ETFs to watch: SPY, TLT
We just closed out a pivotal week, where for the first time in several years, all Signal Sigma strategies have transitioned out of equities. Models are now focused solely on Gold and Commodities, complemented by a generous cash position. The underlying fundamental motivation hinges on the CPI reading that came out on Friday. YoY inflation was reported at 8.6%, boosted by motor fuel and transportation (energy costs). But the problem lies in heightened shelter and food costs, which have a historical record of being hard to revert. This risk of “sticky” inflation, along with a pace of hiring that does not seem to be slowing down, and upwardly adjusted inflation expectations from the ECB weighed heavily on risk assets that brutally sold off. We explore several key metrics below from a fundamental and technical perspective:
CPI Report Breakdown
Both headline and core inflation was reported above expectations. This chart shows the contribution of each category. Of note the “Shelter” and “Food” categories which are starting to impact CPI more than usual. Energy is the usual culprit behind the 8.6% headline rate, but even when we strip that out, the numbers are not encouraging for bulls.
As shown in the chart above, Core CPI (less food and energy) has been relatively stable throughout this economic cycle. The fact that it is not even remotely close to normalizing is a situation that will force Central Banks into more tightening than was expected. Odds of a 125bps hike at the following 2 FOMC meetings (June + July) have shot up to 66%, cratering long term assets (especially unprofitable tech and long term treasuries) in the process. We were expecting inflation to come in at a high number, but not at a new record.
SPY Analysis
Our previous SPY analysis laid out two probable scenarios.
It seemed that scenario 1 was playing out, until late Thursday, when the intermediate stop level for equities was breached at 408. The most recent trading range for SPY gets very wide, bottoming out at 362. It doesn’t mean we will get there in a straight line, but it is a range we are no longer willing to take on equity risk, not even in for a “trading” position.
Treasuries are not faring any better, with both short and long term yields rising. TLT is a position that we monitor, and as of this writing it is not catching a safety bid. Stop loss for TLT is at the most recent lows, where we speculated a short term bottom might be put in, at 113.
TLT Analysis
Market Breadth Analysis
The only silver lining on the market breadth side is the drop in dollar transaction volume which suggests a highly illiquid trading environment. We say silver lining because when transaction volume drops significantly from the mean, a trend reversal is more likely than a continuation.
After Friday’s close, our market Overbought / Oversold oscillator dropped decisively into oversold territory, with the number of Oversold stocks hitting 2 standard deviations once again. This is how a bear market looks like through the lens of market breadth analysis.
Takeaway:
After getting stopped out of our “trading” positions in the Sigma Portfolio on Thursday, equities have now become firmly excluded from our asset class allocation. We are left to contend with balancing 3 major positions in our portfolios: Gold, Commodities, and Cash. We will discuss detailed positioning and technical setup for each in tomorrow’s Portfolio Rebalance article, after our algorithms have had a chance to analyze the latest market moves and today’s close.
Andrei Sota