The market is at a crucial point

It’s been a volatile and difficult year in financial markets (did I need to tell you this?). The Fed unwound its multi-year low inflation high growth accommodative policy – thus popping the post-pandemic bubble. So – Is the bear market over – or is there more pain to come? Today, I offer some potential good news, at least for investors who pay attention to this blog. But there’s some potentially bad news for the markets as well. I’ll conclude with my thoughts regarding the market’s crucial turning point. Finally, some interesting perspectives on the inflation outlook. Enjoy!

Some good news

While the headline returns are dismal, a look underneath the surface reveals strong market breadth. A majority of equal weighted S&P 500 sectors are outperforming their market cap weighted peers, and cyclical S&P 500 sectors (as I have been preaching – materials, commodities) are outperforming the broad S&P 500 Index. The chart below shows us how the SPX (red line) is underperforming the Equal Weight SPX (black line).

You CAN make money in this market, folks. But its all about cyclicals. And now, its the time of that cycle – inflation/ materials/ commodities. That, and trading. No more buy n’ hold.

Some bad news

As the calendar turns to 2023, earnings are the next headwind for the equity market. The market looks at the 2022 equity market sell-off and thinks stocks already price in a recession. At ValueTrend, we disagree. Our view is the market has not priced in negative EPS growth – or a recession! The 1-2 punch of P/E multiple compression and negative EPS growth may be a wake-up call. As I have been pounding the table about– the risk of persistent inflation in a recessionary environment leaves the Fed unable to act too aggressively to fight that inflation.

Result: The market is at a crucial point

My monthly chart below illustrates how it has pulled back from a parabolic move this year, as it did in 2000, 2008, and 2014. We are now testing the uber-long 50 month (red) moving average line. We are also testing a trendline that began in 2009. If the market fails here and breaks that big SMA (as it did in 2000 and 2008) – it could get very ugly. Will earnings be the straw that breaks the markets back? Or will the trendline and 50-month SMA hold?

On the positive side, take a note of the 10-month Rate of Change (ROC) indicator below the price chart. I discussed this in my Online Technical Analysis Course. It can signal market tops (see my small red arrows). It can also signal bottoms when -20 or lower zone. It reached that level recently before reversing up again. So, it may just be that the market holds the line. But then again, the ROC moved substantially lower until the final washout after the 2000 and 2008 peaks. Sooooo……lets just watch the big read line before drawing any conclusions!

Inflation – lasting longer than many expect

I’ll leave you with two quotes on inflation:

1.

“We empirically characterize episodes of large inflation surges that have been observed worldwide in the last three decades. We document four facts. (1) Inflation following surges tends to be persistent, with the duration of disinflation exceeding that of the initial inflation increase. (2) Surges are initially unexpected but followed by a gradual catch-up of average short-term expectations with realized inflation. (3) Long-term inflation expectations tend to exhibit mild increases that persist throughout disinflation. (4) Policy responses are characterized by hikes in nominal interest rates but no tightening of real rates or fiscal balances. Our findings highlight the challenges monetary authorities face in avoiding persistent inflation dynamics following large inflation surges.”

Andrés Blanco
Department of Economics
University of Michigan

2.

“Street models signal that more than 9% of overall monetary tightening will be required to break inflation. That 9%+ combines both interest rate rises and QT. Virtually all of the market’s attention is focused on Fed Funds, but it is the sheer magnitude of the near $4tn of QT that he estimates would be required to break inflation that Solomon thinks investors will be shocked by. At the current run rate of c.$100bn a month, QT would have to be accelerated dramatically. Can the Fed do it and will it do it? Those are the key questions – and the answer is of course it can’t.

Headline CPI declines notwithstanding, Core CPI will remain elevated. We stand by our oft-stated view that core inflation measures will bottom in the 3% to 4% range. We would recant on this view if the Fed raised rates to 9% or 10%, but we view that as incredibly unlikely. A dramatic increase in QT might do the trick, but that would destroy the Treasury market. Ain’t happenin’.” – BearTraps

Videos, including some upcoming guest interviews

I recently recorded a video on the recent Dow Theory Divergence (not a good sign). I also recorded my Armchair Elliott Wave outlook this week. Look for that one to come out next week.

Exciting news: I have two really exciting guests booked for video interviews in the coming weeks. I wont tell you who they are – but they are both massive scores for this blog. Very exciting! Stay tuned!!!!

Also: As has been the tradition for well over a decade, I am going to publish an off-topic blog at the end of the year/ first week of the New Year. This one will have tons of warning labels ahead of time. Not everyone will want to read it. Picture it like spicy food – aka the classic Indian dish, Chicken Vindaloo. Not everyone loves crazy amounts of hot peppers, but for those who do….I’ve got some hot stuff ready to serve up!

I’ll give a heads-up.