President Trump Will Decide On Iran Deal On Tuesday

The S&P 500 was up 0.34% on Monday and the Russell 2000 was up 0.89%. There was a modest pullback in the afternoon which some blamed on Trump’s tweet which stated he will announce his decision on the Iran deal at 2:00 PM today. If you think the President will continue the current agreement, then oil should fall and equities excluding energy should rally. If you think Trump will announce sanctions or tougher goals for Iran’s nuclear program which could cause Iran to retaliate, then oil should rally and stocks should fall. The stock market’s small reaction tells me Trump exiting the deal is priced in. If he stays in, there will be a much bigger reaction than if he leaves.

The chart below shows that oil finally breached $70; it fell about $1.25 because of Trump’s tweet. Oil had rallied in the past few weeks on the expectation that Trump will withdraw from the Iran nuclear deal. The sanction waiver expires on May 12th, so the market anticipated a decision around now. This is sort of like a buy the rumor sell the news event except the news didn’t come out. It was an announcement that the news will be released. As I mentioned, if Trump extends the waiver or announces a new deal with Iran, oil prices will fall sharply. They will rally modestly if Trump ends the waiver and doesn’t seriously look for a new agreement.

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Technicals Very Important To Stocks

As I have been discussing for the past few weeks, I think the technicals are especially important to the S&P 500 as investors decide whether the S&P 500 makes new highs or falls below the February low. The volatility has compressed after the February correction, but the market hasn’t rallied. This is like the opposite of January when stocks rallied while volatility increased. If the opposite reaction were to follow, stocks would rally sharply in the next few days. As you can see from the chart below, the 200 day moving average has been support for the market. The blue line shows the lower highs the market has made; this acts as resistance to the upside. Both the support and the resistance are converging. Unless the market stays within a 66 point range this week, there will be a critical move by Friday.

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Correction Or Bear Market?

According to the fundamentals, the market shouldn’t fall 20% as earnings are growing very fast. Even though the economy has weakened, there was still 2.3% GDP growth in Q1 which shows the economy is far from a recession. The chart below shows this period is closer to the average correction than the average bear market. The MSCI World Index usually hits a new high about 39 weeks after the market peak. That would be about 26 weeks from today. On the other hand, the average bear market since 1979 is down about 14% from the peak by now. Even though it seems like the market has been range bound for a while, we’re not outside the normal correction length yet. The technicals signal some sort of action. An up move would line up perfectly with the average correction. Keep in mind, this is the MSCI World Index and that was the S&P 500. The two are correlated, so it’s not a stretch to use them interchangeably.

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Dollar Rallies As American Economy Outperforms Europe

The dollar index has been increasing lately which is a strong shift against the short dollar narrative. Investors are bearish on the dollar because we’re in a risk on environment and because Trump appears to have a weak dollar policy. Dollar bears claim the index works in long cycles; they say we are still in the early phase of a bear cycle. I don’t disagree with the bear case for the dollar index, but I think that there’s an equally strong bull case.

The Fed is the most hawkish advanced economy central bank as it has been raising rates for 2.5 years. It could either raise rates 75 or 100 basis points this year. That’s bullish for the dollar. Furthermore, the Fed is unwinding its balance sheet while the JCB and the ECB are just starting to slow down their asset purchases. With the recent slowing in the European economy, Draghi has mentioned slowing down the ECB’s balance sheet unwind. That’s a possibility if the ECB cares about reaching its goal of 2% inflation. Recently inflation has fallen. That’s a big deal since, prior to that decrease, inflation was already far below the goal.

This leads me to my second point which is that European economic data has been missing expectations sharply as its economy decelerates. America is seeing some weakness, but nothing like Europe. You can see this in the higher profit growth from S&P 500 firms compared to Stoxx 600 firms. The data below is from April 26th. As you can see, the earnings estimates rose over 8% in the S&P 500 while they fell about 4% in the Stoxx 600 in the same time frame.

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The chart below is an updated result of Stoxx 600 earnings with 60% of firms reporting Q1 results. As you can see, the weighted average earnings are only 1% above expectations as there was flat sales growth and modest EPS growth. This is much less than American firms which would have better numbers even without the help from the tax cuts.

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10 Year Bond Still Sold Short

The 10 year yield has been very flat since April 27th. Its latest yield is 2.95%. The 2 year yield is 2.5%, meaning the difference is 45 basis points. Even though the 10 year yield broke through the psychologically important 3% level for 1 day, it didn’t get renewed momentum to the upside. If the 10 year yield stays at this level, the curve will invert soon as the Fed’s rate hikes have pushed up the short end of the curve. The good news for those who don’t want an inversion is oil prices have been driving inflation up. That could push up long bond yields.

The bad news is seen in the chart below as the 10 year treasury has a record high short position. If that reverses, the yield will fall. That would cause an inversion. Personally, I’m starting to get more optimistic on the economy as I expect green shoots in Q2. This is going against the mainstream as Bank of America just lowered its Q2 GDP growth forecast from 3.7% to 3.2%. Being constructive on U.S. growth makes me less bullish on the 10 year bond.

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