/ September 09 / Weekly Preview
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Monday:
N/A
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Tuesday:
N/A
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Wednesday:
Inflation Rate YoY (2.6% exp.)
Core Inflation Rate YoY (3.2% exp.)
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Thursday:
PPI MoM (0.1% exp.)
Initial Jobless Claims (230K exp.)
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Friday:
Michigan Consumer Sentiment (68 exp.) -
Monday:
Oracle ORCL
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Tuesday:
Dave & Buster's Entertainment PLAY
GameStop GME
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Wednesday:
N/A
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Thursday:
Adobe ADBE
Kroger KR
Signet Jewelers SIG
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Friday:
N/A
Recession Concerns Resurface
Before we kick off this week’s newsletter, make sure you’ve read our Q3 Market Outlook report here. This will provide much needed context into our day-to-day strategy briefings and explain how various scenarios might play out in the economy.
Last week, markets struggled and sold off as slowing economic data and a weak payrolls report weighed on risk sentiment. With the support from corporate share buybacks fading and the risk of a potentially contentious election, major investors will most likely keep to the sidelines in the following months.
SPY was pushed below immediate support at the 50-DMA rather violently on Friday due to the payroll report which we’ll analyze later. As we’ve been discussing in the past couple of weeks, it was very likely for the market to re-test a level of support in order to establish a trade-able “bottom”. We’ve seen these types of “double dips” before and it’s certainly not a surprise to see this pattern develop again. Short term conditions are oversold enough to elicit a “bounce”, but in our opinion there are exactly 2 ways this episode plays out:
Either we get a bounce back above the 50-DMA (and M-Trend) at around $550 or…
We’ll see a full reversal to the 200-DMA (and S1 level) at around $510
The good news is that the market has resolved its previously overbought condition, sentiment has reverted to more neutral levels and either reclaiming support at the 50-DMA or fully reverting to the 200-DMA would be bullish technical catalysts.
As expected, lower prices have incentivised more buyers to show up, driving dollar transaction volume higher. The added liquidity should act as a limiting factor for volatility going forward, especially since many portfolios have now been adequately hedged against more meaningful declines back in August.
All of this is leading to the technical opportunity we’ve been waiting for all summer - a safe and advantageous level to increase equity risk exposure into year end. Of course, this is predicated on our Optimistic and Neutral views for the stock market (which hold 70% combined odds). Unfortunately, in our latest Market Outlook, we have also increased the probability of the pessimistic outcome from 5% odds to 30% odds. This development is almost entirely due to the un-inversion of the yield curve.
To recap, during the past week, the “yield curve” (or the spread between the 10-year and 2-year Treasury bond) briefly un-inverted. A yield curve inversion takes place when short-term interest rates exceed long-term rates. For instance, the yield on the 2-year Treasury has been greater than that of the 10-year Treasury for the past two years. Generally, longer-term investments provide higher yields than short-term ones because of the greater risk associated with time. However, this trend was altered after the Federal Reserve’s aggressive rate hiking campaign, which resulted in elevated short-term yields.
While the yield curve inversion itself signals potential economic trouble ahead, it’s usually the un-inversion of the curve which is a much more timely indicator for a recession.
The 10-2 year yield spread is certainly not the only curve that bears watching (but is certainly the most popular one). Another very common and closely correlated yield curve is the 10 year - 3 month curve, which bears similar characteristics, but is still well inverted at the moment. So does that mean that a recession is imminent, or is one of these curves throwing off a false signal?
As is the case for many technical indicators, multiple signals usually act to “confirm” each other. Such is the case with these two critical yield curves. For now, the interpretation that we give is a “strong warning” coming from the 10y - 2y spread, which is not currently confirmed by the 10y - 3m spread, as the Fed has the highest influence at the 3 month interval. Whenever the Fed cuts rates, the 3-month will also immediately react.
However, there is definitely some weaker economic data that is driving the action of the 2-year yield. Crucially, the yield curve is a leading indicator, while economic data is almost entirely lagging and subject to massive revisions.
A week ago, the BLS revised lower the number of employed persons by nearly 900,000. The ADP Employment change numbers released on Thursday stated that:
“Private businesses in the US added 99K workers to their payrolls in August 2024, the least since January 2021, following a downwardly revised 111K in July and well below forecasts of 145K. Figures showed the labor market continued to cool for the fifth straight month while wage growth was stable.”The job market’s downward drift brought us to slower-than-normal hiring after two years of outsized growth,”
-- Nela Richardson, chief economist, ADP
On Friday, the Bureau of Labor Statistics published the Non-Farm Payrolls report, which was not well received by the market. First of all, the report contained another massive revision to the previous two months of -86K jobs. The June jobs report was revised lower by 61,000 jobs, from 179,000 to 118,000. The July jobs report was revised lower by 25,000 jobs, from 114,000 to 89,000. This means that the July jobs report was the weakest jobs report since the pandemic in December 2020.
Both public and private sector payrolls missed expectations, coming in at a combined 142K jobs, versus 160K expected. Furthermore, -438K full time jobs were lost and +527K part-time jobs were created, meaning that the entire monthly growth was only due to part-time workers.
The number of workers currently holding a part-time position, but looking for full-time employment increased to 4.83M in August. We have scaled the chart below to the same timeframe as the yield curve analysis above on purpose.
When stacking the 10y -2y curve and “Part-Time for Economic Reasons” series on the same graph, we begin to better appreciate the relationship of the yield curve to the labor market, and note its predictive properties. Needless to say, whenever both series start to meaningfully turn up, a recession ended up becoming the inevitable conclusion.
We hope the analysis above has shed light on the reasons for the market sell-off on Friday. Although consumers may currently support growth, this can and will shift rapidly in the event of job losses. The consumer is a fickle beast and changes in spending behavior can happen very fast.
The week ahead contains key inflation data on Wednesday, but very few catalysts otherwise. We expect trading to be influenced primarily be technicals outside of Wednesday.
Inflation figures will be the final major data point to influence the Fed’s policy decision on 18 September (9 days from now). Interest rate traders are assigning a 25% probability of a 50 bps cut at the next meeting and more than 100 bps by year end (!).
Our Trading Strategy
“It is difficult to make predictions, especially about the future." - Yogi Berra’s timeless statement is very applicable today. That is why our Market Outlook analysis provides various “scenarios” and our portfolio actions emphasise risk management as a process above all else.
Logic dictates that we can’t get a drawdown in the market on positive news. Investors need a valid reason to be worried about the future in order to liquidate their holdings. At the time of this writing, the market is oversold enough in the short term as to elicit a bounce. We do not expect this bounce to clear resistance at the 50-DMA. If we were excessively allocated toward stocks, we would reduce our exposure on the bounce. Thankfully, our position is balanced and we don’t need to do anything except wait for a better opportunity to increase risk exposure.
But why increase risk exposure if a recession seems to be just around the corner? Well, consider that between a yield curve un-inversion and the actual onset of a recession, 6 to 12 months may pass. Furthermore, the recession is dated by the NBER, which takes another 6 to 12 months. Although the long-term risks are clearly apparent, as previously mentioned, they may take significantly longer to materialize than one might logically expect.
In the meantime, our most optimistic scenario is “in play”. As long as that is the case, and until it is invalidated by price action, we’ll act according to its risk-reward proposition. At prices below $520 on SPY, for example, that ratio becomes very attractive, and adequately compensates us for the perspective of an economic downturn sometime in the next 2 years, especially if “support holds”.
Signal Sigma PRO members will be notified by Trade Alert of any live portfolio changes (if subscribed). If you’re not on this plan yet, you can get a free trial when you join our Society Forum. If you need any help with your trading strategy (or would like to implement one on your account), feel free to reach out!