/ September 16 / Weekly Preview
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Monday:
N/A
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Tuesday:
Retail Sales MoM (0.2% exp.)
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Wednesday:
Building Permits (1.41M exp.)
Fed Interest Rate Decision (cut expected)
FOMC Economic Projections
Fed Press Conference
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Thursday:
Initial Jobless Claims (230K exp.)
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Friday:
N/A -
Monday:
N/A
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Tuesday:
N/A
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Wednesday:
General Mills (GIS)
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Thursday:
Darden Restaurants DRI
FactSet FDS
FedEx FDX
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Friday:
N/A
The Fed Faces Unprecedented Uncertainty
Last week, markets had a pretty volatile couple of sessions that ultimately resulted in a clearing of short term resistance. The set-up started with last Friday’s session (06), which saw the S&P 500 break below the 50-DMA. From there, stocks vacillated in a tight range until Wednesday morning, when CPI data was released. Initially, there was a sharp -1.5% selloff in response to the slightly hotter than expected report, which re-tested Friday’s lows. Things looked a bit dire, but strong words from Nvidia’s (NVDA) CEO sent stocks (and crypto) surging higher to a +1% gain by the close.
That intra-day reversal cleared resistance once again, confirming the previous support, allowing us to add to equity exposure and continuing the bullish momentum into Friday (13). The 20-DMA was cleared as well, while the MACD signal has crossed over to a positive reading. From a technical perspective, this is excellent news. The next logical step for the S&P 500 would be the setting of new all-time-highs, while short-term upside currently resides at $588 (R1, +4.62%)
Investors are not exactly clamouring to chase the rally here, so gains might become harder to come by in the next couple of weeks, especially as the U.S. Presidential election looms and share buybacks are paused due to most companies being in the blackout window.
However, compared to the last time the market was priced similarly, we are now seeing much improved dollar transaction volume, despite the overall metric still sitting below the recent average.
A possible reason for the hesitation may be related to this week’s key economic event: the Fed’s interest rate decision on Wednesday. A highly unusual dynamic occured after the CPI report was released: probabilities of a 50 bps cut as priced by the Fed Fund Futures market initially fell to around 15%-20%, following the August inflation report. This was due to the Core Inflation Month-on-Month reading of +0.3%, versus +0.2% expected. A hot print diminishes the odds of a larger rate cut, so the market’s behavior was logical.
Nick Timiraos (of the WSJ) then published an article, suggesting a 50 bps cut is seriously being considered. The futures market immediately re-priced to around 50%-50% by Friday’s close. This is essentially a coin flip and it’s not what the Fed usually wants to see with just a couple of days to go until its next policy meeting.
The Fed has designed a “forward guidance” policy transmission mechanism that works through both official press releases and certain well known journalists. The point of this whole exercise is precisely to avoid disappointing or surprising the markets whenever a decision is announced. Odds of a certain rate move just days before a meeting are usually stacked in favor of the actual outcome (at least 80%, if not 90%). As things stand at the time of writing (Monday morning), there is no clarity at the moment, with Fed Fund Futures showing a 59% to 41% probability split between a 50 bps cut and a 25 bps cut.
Another “story” may come out today, and finally tilt the odds one way or another. However, if this is the state of the futures market Wednesday morning, it will be interesting to see how investors adapt to a new regime where “forward guidance” is practically dead. Unfortunately, that would imply more volatility and less predictability all else being equal.
In our opinion, the CPI report itself is pointing toward deflation. The latest report indicates that costs for homeowners’ equivalent rent (housing), transportation, recreation, and education have increased. In contrast, energy costs, food, and other goods and services have decreased.
Declining inflation can be a net negative for the economy, as it typically signifies reduced demand. While overall inflation rates remain above the Fed’s target, the inflation rate excluding healthcare and housing costs is considerably lower. Since many Americans have fixed rent (or mortgage payments) and fixed healthcare expenses for a defined period, the measure that excludes these two factors provides a better cost of living estimate. Recently, this adjusted measure has fallen to an annualized rate of just 1.24%. This indicates that economic demand is likely much weaker than the headlines suggest.
Alternate measures of inflation (Truflation, Adobe Digital Price Index) are painting a picture of reduced demand. The question for the Fed is which data set is more relevant, and how much they want to risk stoking inflation back up again.
Sharp declines in oil prices often align with downturns in economic activity, decreased inflation, and lower interest rates. This relationship highlights how oil prices serve as a good indicator of supply and demand dynamics in the economy. Oil is crucial in daily life, as it is used in virtually everything ranging from agriculture to various goods and services -- as such, the demand side of the equation should be strong.
For the last few months, global demand for oil has been declining. Expectations for a global economic rebound might be overly optimistic, if we are to judge strictly by the price of crude, now at -1.21 standard deviations from the mean. Spot prices currently reflect the difference between a build-up in supply and a decline in demand. If this dynamic does not meaningfully reverse soon, the Fed will be facing the prospects of deflation and a 50 bps cut would be favored.
At the other end of the spectrum, this alternate-data dashboard provided by Apollo suggests there is no chance of an imminent recession. Many discretionary metrics are included in their assessment (restaurant, hotels and show bookings) and they paint a pretty robust picture for upcoming GDP calculations. Empirically, we can say that we agree with the data presented below, despite the slightly ambiguous terminology.
Our Trading Strategy
We will end today’s newsletter on another technical note, presented by Sentimentrader. According to their research, S&P 500 returns following a -3% decline and +3% reversal rally occurring within 3% of a 1-year high is a very bullish signal. This just triggered in the past week. The 12-month mean return is +16.2%, with 90% of instances leading to positive results.
Their analysis closely aligns with our own fundamental calculations, which imply an upside of ~20%. For now we remain allocated to equity risk and looking for opportune moments to increase exposure further.
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!