Snapback Rally - Another Big Rally

The stock market is overbought, and the economic reports are missing estimates. Earnings estimates have fallen to the point where 1st half results are expected to barely show any growth. But stocks still roared higher on Friday. 

Bullish investors see a scenario where economic growth recovers as the Fed has stopped pressing on the breaks because inflation is modest. 

Investors also know the negative sentiment indicators will reverse. Especially now that stocks have rallied, the shutdown is over, and the worst fears about the trade war have been allayed.

Snapback Rally - The Bears Are Pressing Their Luck

On Friday, S&P 500 was up 1.09%, Nasdaq was up 0.61%, Russell 2000 was up 1.56%. VIX was down 8.08%. The S&P 500 is now up 18.1% since the Christmas Eve bottom and only down 5.3% from the record high in September. 

Even though it doesn’t seem like it because stocks are rallying, bears are pressing their luck, trying to profit off a second leg lower. 

They really think the September record high will hold. I thought it would too, but I reconsidered my position after I reviewed the latest revenue growth estimates. Usually, revenue growth is lower than EPS growth, but not in this case.

Snapback Rally - Best Rally Since WWII

S&P 500 is now up an astounding 10.72% year to date. This is one of the fiercest rallies I’ve seen in my life. 

The CNN fear and greed index increased from 65 to 70 which is the highest reading since the recovery rally started.

As you can see from the chart below, the S&P 500 is up the most out of all the 3-month drawdowns of +20% since WWII. 

This chart ends on February 11th. Since then, the S&P 500 is up 2.42%. In 119 years of Dow Jones Industrials history, it has swung from a 52 week low to an 8 week winning streak of 15% or more twice. 

The first was November 2002 and the second was now. This shows how rare and severe this rally has been. 

It makes some investors make wild proclamations that have no source such as believing the government is behind the rally (the plunge protection team). There is no secret to why stocks are up.  

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On Friday, all the sectors were up. The 2 sectors up the least were the utilities and communication services as they increased by 0.28% and 0.4%. The 2 best sectors were the financials and energy as they were up 2.02% and 1.59%.

As you can see from the chart below, the total commercial hedges in the S&P 500, Nasdaq, and Dow Jones Industrial Average futures nearly went positive in January. Hedgers covered their positions aggressively. 

Currently, it seems very reasonable to hedge your long positions because this is one of the best snapback rallies ever. This chart is actually modestly bullish. Hedgers haven’t covered as much as they did in the early 2016 snapback rally and in late 2011.  

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Snapback Rally - January Core CPI Falls Slightly

As I mentioned earlier, inflation isn’t a problem, which is great news for stocks. 

Headline inflation was 0% month over month which missed estimates for 0.1%. The December report was revised upwards from -0.1% to 0%. On a year over year basis, headline inflation fell from 2% to 1.6% because of the decline in oil prices. This beat the consensus for 1.5%. The December report was revised upward by 0.1%. 

As you can see from the chart below, headline inflation was the lowest since September 2016. While the Fed focuses on core inflation, this report is great for consumers as real wage growth should accelerate.

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Core CPI was 0.2% month over month which met estimates and was the same as December. Year over year core CPI was 2.2% which beat the consensus for 2.1% and was the same as last month. Technically, it wasn’t the same as last month because that number is rounded up. 

Core CPI was 2.148% in January and 2.214% in December. That’s almost a full tenth lower. 

Snapback Rally - This was the lowest core inflation reading since April 2018. 

The 2-year stack was almost exactly the same as it was 3.98% in both months, rounded to the nearest hundredths place.

February 2018 core inflation was almost the same as January, so the rate should be steady next month. That will be the last report before the March 20th Fed meeting. 

Currently, there is a 98.7% chance the Fed maintains rates in March and a 1.3% chance the Fed cuts rates. The February inflation report probably won’t affect this decision. Obviously, if the economy falls off a cliff, then the Fed will cut rates. But nothing within the realm of reasonably likely possibilities will do it.

The March report is where the comps get much tougher. March 2018 core CPI was 2.1% which is about 27 basis points higher than February. 

If the 2-year stack stays about the same, core CPI will fall below the Fed’s 2% goal. I think the Fed is banking on this occurring to support their new dovish tone. Keep in mind that the core PCE report is usually lower than the core CPI. So the Fed will have even more wiggle room. Core

PCE has never been able to sustain itself above 2% this expansion. I don’t anticipate that changing with rates at the highest point of the cycle and global economic growth slowing.

Snapback Rally - Conclusion

This has been one of the best snapback rallies ever. 

Stocks are so overbought that I could easily see stocks falling 5% in the next week. However, I don’t see the market retesting the December low. There’s still a small chance of a recession and low inflation has allowed the Fed to be dovish. 

If jobless claims spike in the next few weeks and Redbook same store sales growth weakens, I will change my mind on the market retesting the lows.