Powell Can’t Raise Rates As Economy Remains On Life-Support

Last week, we stated:

“With valuations still extended, the recent correction didn’t reduce speculative fervor. Furthermore, prices remain well deviated above long-term means, particularly in the small and mid-cap space.

While more stimulus will likely support prices over the next few weeks, the threat of rising inflation and interest rates could undermine growth expectations.”

Over the past week, the market didn’t make a lot of headway, as price rises were limited while intraday dips got repeatedly bought. Such is what we would expect with the “money flow” indicators we have discussed over the last several weeks back on “buy signals.” (Importantly, note that Friday’s early morning decline held the uptrend line from the October lows.)

However, while overall market action remains bullish, there are two concerning points shown in the chart below. The highlighted box shows money flows remain negative currently. As stated previously, such suggests rallies may stay limited for now. The second is the negative divergence of the actual index (red dashed line) which also confirms the weakness of the underlying “buying.”

With our indicators still on “buy signals” across the board, the bias of prices near term is to the upside. However, with the oscillator now pushing into the upper zones, and starting to roll over, with the market overbought, further price increases will become more challenging.

We suggest using rallies over the next week or so to raise cash and reduce risk.

Rate Surge

Another more critical concern remains interest rates. The recent surge in rates has caused problems over the “growth” trade. As shown, the annual rate of change in rates has surged by 146% in recent months. That spike is unprecedented over the last 20 years but is a function of rates hitting 0.50% during the pandemic.

However, the recent underperformance of QQQ versus IVE (Value) is also unusual from a historical perspective. Previously, during swings higher in rates, the QQQ’s outperform IVE as investors sought companies that could generate earnings and had lower leverage. 

Given the massive debt load corporations are carrying currently, combined with an inability to pass along higher input costs, I suspect we will see a rotation back towards growth. Such is particularly the case with companies already struggling with thin margins (especially in the small and mid-cap space.) 

We suspect we may see a rotation from “value” back to “growth” sooner than later given the massive overbought conditions of the “value trade.”

For now, we are primarily maintaining our core positions. However, we did recently take profits in the highly overbought energy and financial positioning. We are starting to seriously look at further increasing our “growth” side of the portfolio during the next correction.

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