I wasn’t planning on writing today. I can’t remember the last time I didn’t write a Monster Market Commentary article on Sunday, but I wanted to take a break. With earnings season this quarter and the Fed, I was feeling a little burnt out. I also overdid it on exercising today and even tried to run a bit; my foot has been tingling since then. I’m just 3.5 months post-surgery on my back, and despite feeling great after it, it can take a good six months to one year until the nerve fully regenerates. So I’m on the couch with nothing to do, so that means we can talk about the market.

Global Rates

This past week was crazy, especially with what was happening in bond and the currency markets. Rates for the Australian 2-year rose by 50 bps, 50 bps! They shot up to 60 bps. That is a multiple standard deviation move, something that should never happen. But this happens when a central bank with yield curve control doesn’t buy the bonds they are supposed to. It appears the Australian market is challenging the RBA in a significant way, or worse, losing confidence in their ability to control inflation.

Fed

The FOMC meeting is this week, and as we have talked for months, I expect the Fed to announce the start of tapering its asset purchases at this meeting. At this point, if they don’t, the bond market’s current position of uncertainty could become an outright loss of confidence if the Fed doesn’t act.

The spreads on the yield curve are already contracting, with the short end of the curve rising and the long end of the curve falling. It is a sign that the market is getting worried about an economic slowdown or a Fed policy error. Whatever the case, it is not a good sign.

The market is also pricing in rate hikes starting this coming June and potentially five rate hikes by the end of 2023.

Dollar

Additionally, the US dollar surged on Friday, especially against the euro. The move higher against the euro was not a surprise; it should have started on Thursday, but it didn’t. In the meantime, key support levels held, and I think this is the start of a massive move higher for the dollar. I know plenty of people believe the dollar will not rise, but I have a great deal of confidence it will. There are plenty of countries facing the same inflationary pressures as the US. Plus, the Fed will be ending QE well ahead of the ECB or the BOJ, and at least for now, as noted above, Fed Fund Futures believe the Fed will start raising rates ahead of the ECB. So this will help to push the dollar higher against the euro while Japan is still trying to figure out how to get its economy growing.

Additionally, bond yields in the US are much higher than in many developed countries, luring buyers of US debt and forcing them to buy dollars.

Tighter Financial Conditions

Combining a Fed taper and a stronger dollar will cause financial conditions to tighten; how quickly they tighten depends on how fast the market moves. Those tighter conditions almost always lead to equity market volatility.

It seems that tighter conditions, especially in leverage, have a direct impact on margin balances. Even recently, when those conditions began to increase in August, that negatively impacted margin balances. If those conditions should continue to rise or, worse, stay persistently high, it is likely to result in margin balance contracting.

(Mott Capital)

Falling margin balances are higher correlated to weak equity markets.

(Mott Capital)

S&P 500 (SPY)

The S&P 500 had a solid finish to the week, and from what I read all week, the inflows were robust because of month-end and rebalancing that was taking place. So I will leave my pattern for the wave B top for now since the index finished just 8 points above the prior higher, which is a rounding error at today’s level. If so, then Friday was the high for now, with a meaningful reversion to come. We will know pretty quickly on Monday what the outcome will be.

I shared this Saturday on Twitter. It shows the S&P 500 coming off the 1987 and the 2009 lows, and it is highly correlated, at 0.95. The 2009 version of the S&P 500 (black line) rose faster than the 1987 version (Blue line). But both then met and lined up starting in 1998/2018 time frame. If this turns out to be as accurate as it has been, the rally in the S&P 500 is just about finished, and the highs are in, with any dip and rally from this point not producing a meaningful new high. This chart currently places the S&P 500 in the April 30, 2000 timeframe.

Amazon (AMZN)

I thought Amazon reported a terrible quarter. The company is now seeing higher costs and slower growth, which is the worst kind of news possible for a growth stock. If not for AWS, the company would have had a negative operating income. AWS accounted for 100% of Amazon’s operating income. It is the reason Amazon will never spin off AWS; it simply can’t afford to. Maybe the stock fills the gap back up to $3,440. It really shouldn’t, but it could. I still think it heads to $3,000 over time and probably lower. 

Apple (AAPL)

Apple results were acceptable, even though they missed expectations on revenue. They didn’t give any guidance in terms of revenue, and from listening to the call, supply chain issues will persist, so it sounds like Apple is not going to have an easy time of getting all the supply it needs, in what is their most important quarter of the year. I have been looking for the stock to fall to the mid-130’s since July. I am still waiting.

Tesla (TSLA)

Tesla is still squeezing, and the key at this point is waiting for that call volume to come down. Call volume appears to have peaked, but the volume still seems healthy, which means that IV needs to rise a little bit further still. I still think it reverts to the $760ish range.

Caterpillar (CAT)

Iron ore prices are dropping like a stone, and so are shipping rates. I’m not sure why Caterpillar has not started to see the effects of what appears to be stalling growth in China. The stock tried to overshoot resistance on Friday around $204 and closed right there. At this point, it looks like a failed break out, with a good chance the stock drops back to $192.

Transports

The Nikkei appears to have about 32 day lead over the Dow Jones Transports, which would indicate the highs for the transports are in.

Good luck this week,

Mike.