Unexpected Inflation Headline - Who Should You Believe?

Welcome to this week's market outlook. We hope you had a good week, although it was a turbulent and difficult period for investors in the market. The surprising (and unexpected) headline on the CPI (Consumer Price Index) came in at 3.5% for March, significantly higher than February’s 3.2% (which was higher than expected in February).

This shocked the stock and bond markets, and it seemed to indicate that inflation is proving “stickier” than the Fed would like. The market was down over 1% on Wednesday for most indices (down over 2% on small-cap stocks). However, a meaningful rally on Thursday recovered most of that down move from the day before.

On Friday morning, the PPI came out much more tame (which was good news). However, headlines regarding bank earnings, tensions in the Middle East, higher-than-expected interest rates, and negative earnings expectations heavily driven by JP Morgan’s earnings conference call spooked the market yet again. The markets gave up all of Thursday’s gains, plus some.

For the week, the S&P was down -1.5%, the Nasdaq 100 was only down 0.50%, but small-cap stocks (IWM) sank the most at -2.8%. That makes sense, given the much greater dependence that smaller companies have on interest rates. See chart below:

Fixed income funds and anything related to interest rates (small- & mid-cap stocks) were the most effected this past week. We wanted to illustrate just how quickly the 10-year interest rates reacted to the higher CPI number that came out. We illustrate this in the two charts provided below. The first is the most recent action seen since April 1, and the second is the rise in interest rates since Jan. 1, 2024.

Since April 1, 2024, the 10-year interest rate has increased 5%. See below:

Since Jan. 1, 2024, the 10-year interest rate is up 20%.

In the grand scheme of things, we are still close to new all-time highs set by the S&P 500 on March 28, 2024. Since then, we have seen a pick up in volatility and the daily market swings, but we are only down -2.3% since hitting the last all-time highs on March 28, 2024. Putting this in perspective is Ryan Detrick’s chart below:

Are we in for more downside? We will explore this shortly.


Who are You to Believe?

There is a ton of news out there daily with contrarian points of view about our economy, inflation, debt, the markets, geopolitical risks, and an additional handful of potentially market moving data. Then there is what the Fed says.

Starting late last year, both Mish and I were redundant in our calls for “Higher for Longer” with respect to interest rates as well as inflation. We both repeated this mantra over and over. Mish was very clear when she laid out her projected path that historically inflation is stickier than investors are expecting. Inflation doesn’t just disappear overnight. Additionally, with all of the Government spending continuing, there is still an abundance of quantitative lubricant in the economy that will show up as inflationary.

Going back to the fall of 2023, we indicated that inflation was around for a much longer time than the deceleration that the analysts and pundits were projecting. Moreover, both in late 2023 and early 2024, we suggested that our opinion is that interest rate cuts would come later in 2024 and not be anywhere close to 6-7 times.

Since the beginning of the year, we were unequivocal in our belief that interest rate cuts wouldn’t happen until after midyear. Over the past two weeks, we suggested that we were likely to see 3 or less interest rate cuts, if any.

Bloomberg reported on Saturday that there are now two new possibilities for the global inflation fight. First, the European Central Bank (ECB) may attempt something that diverges from the US. They are suggesting they will cut in June “even if the US holds fast.” 

“It’s time to diverge,” Bank of Greece Governor Yannis Stournaras said. “The situation in the euro area and the US are completely different.”

The other possibility? Brace yourself, said Bloomberg. If US inflation remains sticky, the Federal Reserve might do more than simply push back rate cuts. How about another rate hike? Bloomberg pointed out that robust consumption and investment, as well as easing supply-chain problems, have fueled strong US growth despite higher interest rates.

Most of the investment banks have recently changed their tune. We provide below a comparison of what the big banks are saying about interest rate cuts in 2024:


Market Uncertainty Will Continue

There has been a sharp pickup in the volatility readings indicating that fear is slowly creeping back into the markets. Given that Wednesday and Friday were two very volatile down days, we would expect this.

This is also being promulgated by the heightened geopolitical risk in the Middle East as well as Russia’s war rhetoric regarding NATO countries. We can see that both inflation and geopolitical risks are taking hold in the metals markets, as gold, silver, and even copper are making new daily highs (for gold, it is new all-time highs, but if you factor in the declining value of the US dollar along with inflation, we are not yet at all-time highs). See volatility (VIX) chart below:

There are negative and positive signs on what the stock market may do in the near future. We present both the positive and negative points of view below.

You may recall several charts we have shown over the past 60 days that indicate what might occur as the stock market made numerous new all-time highs. Most of these charts have been positive and indicated that momentum would likely continue.

You likely have heard of the strong upward bias that has transpired historically when the markets have rallied for five straight months. We would like to remind you that we are in an election year with an incumbent running for re-election, and that typically helps support a bullish narrative.

We offer the following chart to show that April tends to be weak right before the 15th (tax date) and picks back up later in the month.

If the market plays out to script, according to the following analyst, we have only a possible small correction followed by new highs.

Also, next week tends to be one of the strongest weeks of the year for the tech heavy Nasdaq 100 (QQQ) market. We're not sure that this will play out in 2024 given higher interest rates and significant geopolitical risk, but anything is possible. See chart below:

Below is another chart showing a neutral to positive outlook for stocks, illustrating weekly inflows to different asset classes. It appears that money continued to flow into higher risk-on asset classes. But, outflows from high yield bonds indicates “risk-off” sentiment. Yet bond funds have begun to pick up large inflows as institutions are rebalancing their portfolios and moving money to more conservative fixed income. See chart below:

On the negative side, several indicators (including a higher VIX) point to possibly more downside. Recall the chart earlier by Ryan Detrick, which suggests that good market years typically endure at least a 10% pullback like we experienced during 2023.

Here are a couple of charts that indicate there could be some market trouble ahead. The first shows just how little buying is going on from corporate insiders. This chart indicates that corporate insiders have slowed, if not stopped, purchasing company stock, most likely due to their recent lofty levels. See chart below:

Large money managers are also rebalancing and rotating out of high momentum stocks (this includes higher yielding bonds).

A good example of this is Goldman Sachs Asset Management (GSAM), who recently told Bloomberg that they have been reallocating portfolios out of technology stocks and into the much more attractive energy sector. Here is what they recently shared with Bloomberg:

“We like taking profits on technology and moving toward other sectors,” Alexandra Wilson-Elizondo, co-chief investment officer of multi-asset solutions said in a phone interview.

The firm believes tech shares will come under pressure and prefers areas like energy and Japanese shares.

In the tech industry, “the risk-reward profile is skewed to the downside,” she added. “While we still believe in being long equities and having them in the portfolio, we think that there are some more attractive opportunities to access.”

Here are a few charts that illustrate technology stocks have recently “stalled.”

Our conclusion: Risk management is more important than ever. Make sure you have your stops in place and have an “exit plan” for getting out should this pullback materialize into more of a correction. Additionally, sell calls on long-term holdings or buy puts and consider the use of inverse ETFs to hedge some of your portfolio exposure.


Energy Stocks & Gold (and Gold Miners) have been the Recent Winners

Both Mish and I have recently been extolling the reasons to buy oil, gold, and silver through ETFs, such as USO, GLDSIL, and GDX. All have put in multi-week highs and been among the best asset classes to own recently.

However, gold and energy stocks may be getting ahead of themselves (you may recall a chart from two weeks ago indicating that when gold hits a new all-time high, it has always been higher six months later). See the two charts below indicating how stretched gold and energy stocks may be for the time being:

Finally, here are some other factors that may have played a part in the week's trading.


Risk-On

  • Value (VTV) has given up its short-term leadership against Growth (VUG), and VTV has now closed beneath its 50-day moving average.


Risk-Off

  • 2 of the 4 key US indices closed beneath their 50-day moving averages for the first time since November 2023.
  • The Russell 2000 Small Cap index is now negative for the year.
  • All 4 key US indices have reported negative volume patterns over the past two weeks, with the Dow looking the worst after witnessing six distribution days and zero accumulation days.
  • Every major market sector was negative over the past five trading days, with Technology (XLK) moving into a warning phase.
  • The McClellan Oscillator continued to drop for both the S&P 500 and Nasdaq Composite.
  • The cumulative Advance/Decline line has broken below its long term trendline dating back to late October 2023.
  • The short-term Volatility ratio (VIX/VXV) continues to deteriorate and is in bearish mode.
  • Cash Volatility is in a strong accumulation phase and is trading at its highest levels since November.
  • The number of stocks above key moving averages collapsed this week across all major timeframes, but appears to be oversold on a short-term basis.
  • Interest rates remain under pressure, with rates in bear phases across the yield curve due to inflationary pressures.
  • The US dollar (UUP) jumped sharply and closed above its 200-day moving average for the first time in 2024.
  • Foreign equities (EEM & EFA) followed in the footsteps of US equities and broke down this week.


Neutral

  • Risk gauges remained at a weak neutral reading.
  • Copper, gold, and oil all made new intra-day highs before correcting, indicating markets have been running a bit rich and may now be subject to a bit of mean reversion.

More By This Author:

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