Higher for Longer … Probably Not a Reference to Stock Prices

DJIA:  34,070

Higher for longer … probably not a reference to stock prices.  Did we miss something Wednesday, did the Fed actually raise rates?  Were Powell’s comments really new or that much of a surprise?  It’s tempting to say the market overreacted, but so it goes in weak markets.  If not bad the news is taken as such. While it has been a bit higher and a bit lower, the S&P is where it was in June, what we call a trading range.  And the Index has held 5% or more above its 200-day for several months.  S&P components, however, have been telling a different story with fewer than 60% above their own 200-day.  By way of perspective, when the S&P is 5% above its 200-day a median of 80% of components are above their own 200-day, according to SentimenTrader.com.  For all NYSE stocks, fewer than 50% are above their 200-day.  These are not bell-ringing negatives, and typically drag on for a time.  All of these divergences, however, leave the market vulnerable.

Meanwhile, the NASDAQ has had its own technical issues.  Over the last few weeks, the NAZ 100 had moved higher, while the percentage of stocks within that index at a 12-month low more than doubled.  Of late the large caps have masked much of the weakness, and this seems particularly true of the Semis.  While the focus has been on Nvidia (410) and a few others, and while the Semiconductor Index has held together, much like the NDX weakness among the rank and file has been rather pervasive.  Look at Taiwan Semi (85), which started the recent weakness.  The much-vaunted Arm (52) IPO struck us as a real bell ringing event.  Already down more than 20% from its high a few days ago, the company does more business in China than Apple (174).

We know Tech stocks don’t like rising rates, but it looks like the regional banks may be getting jammed again as well.  Regionals are 20% or so of the Russell 2000, and that’s now below its 200-day.  Hardly the same picture but the Econ-sensitive stocks like Parker Hanafin (382) have begun to roll over. Then there’s the weakness in retail and the credit card lenders.  It’s enough to make you think what soft landing?  The FANG and FANG+ stocks haven’t exactly been immune to the weakness but have held together reasonably well – sort of in their own world when the world isn’t such a happy place.  Impressive amidst Wednesday’s mess was the breakout in IBM (147).  Oil and oil stocks have gotten out of sync recently, with the latter the weaker – not usually a good sign.  That said, something seems good for refiners like Valero (146).

Are the Utilities so bad they’re good?  The XLU (63) is down about 12% over the last year, out of favor along with other safe stocks like food and beverage shares.  Higher rates also have made utility dividends less relatively attractive.  A recent Barron’s article also pointed out the companies are adding clean energy plants faster than they’re retiring the old ones, allowing them to grow their rate base and, hence, their profits. Unimpressed by the positives, 90% of the components of the XLU reached a 12-month low recently.  This backdrop has led to higher prices for XLU over the next 6 to 12 months, according to SentimenTrader.com.  It also seems interesting and surprising that there has been a spike in Put buying here.

The Fed’s “hawkish pause” no doubt was intended to curb the market’s enthusiasm.  Something was different this time, however, at least for now it seems to have worked.   Powell often talks hawkish, but the market typically sees through him, betting he will buckle at the first sign of trouble.  Looking at the Fed funds futures, the Fed market as it were, the possibility of another hike this year isn’t taken seriously.  The reason stocks may have

taken Powell more seriously this time is that the market is in a relatively weaker technical position.  Remember, too, at play here are the debt ceiling and the auto strike.  Selling on the Fed news may be an excuse to get out ahead of these other problems.  In any event, what’s needed is better numbers from the average stock, those A/Ds and those stocks above their 200-day.

Frank D. Gretz

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Stuck Inside of Mobile… With the Memphis Blues Again

DJIA:  34,907

Stuck inside of Mobile… with the Memphis blues again.  While that Dylan lyric would seem to have little to do with the stock market, that word “stuck” brought it to mind.  It pretty much says it all when it comes to our view of the market these days.  The major averages are on or just above their 50-day averages.  Our preferred look at the market, stocks above the 200-day average, has hovered around 50% since the start of August.  Granted 70% or more here is a good figure, but 50% or less means half of all stocks on the NYSE are in downtrends.  Meanwhile, the Russell is below its 50-day and teetering on its 200-day.  Regional banks, 20% of that Index, are well below the 200 and look about to break again, leaving you to wonder if there’s a message there.  The momentum measures we follow had turned marginally positive in late August, but since have rolled over again.  They don’t usually change so quickly, but you know what Keynes used to say.

In Isaacson’s biography of Elon Musk, he recounts a meeting between Musk and Bill Gates.  Musk’s first question to Gates was whether he was still short Tesla (276).  He was and apparently went on to explain why, but our point is there are different opinions about Tesla, even among reasonable and smart people.  For our part, we’re just here to talk about a chart pattern we like, and for now that happens to be Tesla’s.  Price gaps are one of our favorite technical patterns, yes they are technical patterns, and yes Tesla has one.  They happen when the low price of one day is enough above the high price of the previous day, that on a bar chart a gap appears.  Technical analysis is an analysis of supply and demand, and what could be more indicative of demand than enough buying to cause a price gap?  In the case of Tesla’s gap Monday, it also took the stock back above is 50-day average.  Some consolidation would not be unusual, and the stock now needs to hold above the gap and the 50-day.

To continue this impromptu tutorial on price gaps, how about that Oracle (114) – a good chart until Tuesday’s downside gap of more than 10%.  Yet another reason this isn’t coming to you from the Côte d’Azur.  Prices usually follow in the direction of price gaps, whether they be up or down.  The exception is when the gap does not change the overall trend.  In the case of Oracle, it pretty much continues in an overall trading range going back to mid-June, and the stock remains above its 200-day average.  Oracle was among those stocks we mentioned last time, calling them the “retro Techs.”  To Dell (71), IBM (147) and Cisco (56) we might have added Intel (39).  While everyone frets over Nvidia (456), ironically it’s Intel, and even Micron (72) that have performed the best. When it comes to Nvidia, the chart it’s still fine, but like the market stalled.  We wonder too, if the Arm offering may have siphoned off a little Semi money.

A new concern this week was the poor action in what we have called Econ-sensitive stocks like Parker Hanafin (395) and Eaton (222) – the latter having dropped 20 points in two days.  It is the largest holding in PAVE which now has taken out a couple of support levels and the 50-day.  We have used these stocks as an argument against a recession, and if that’s changing so too would our recession opinion.  Meanwhile, the case for recession has always seemed to lie in the consumer, based on the action in retail and lenders like Capital One (102).  A couple of bad days doesn’t mean it’s time to panic, but it’s certainly time to pay attention.  In another somewhat retro move, some of the FANG+ names are back on track.  Most of these, Tesla being a prime example, seem in their own world rather than market sensitive, perhaps the perfect thing for a stuck market.

After last week’s spate of selling, this week’s CPI and PPI could have been taken as good or bad.  If the market makes the news, the market’s lack of reaction offered little insight.  And after a worrisome Wednesday, Thursday’s strength was a welcome relief, not so much for the strength of the Averages as the 3-to-1 A/Ds.  One day is just that – what’s needed is more evidence upside momentum has been regained, that is, more days like Thursday.   It’s an interesting overall backdrop.  Despite the inverted yield curve, a contraction in money supply and declines in leading economic indicators, most have turned optimistic – soft landing, and so forth. Goethe said the intelligent man finds everything ridiculous, or is the market just doing it’s discounting thing.

Frank D. Gretz

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US Strategy Weekly: Not Complacent About Inflation

It is a very busy news week. The Department of Justice is suing Alphabet, Inc. (GOOG – $136.07) in federal court for anti-trust violations. Republican US House Speaker Kevin McCarthy launched an impeachment inquiry into Joe Biden alleging that his son, Hunter Biden, and the Biden family profited in business dealings with foreign entities while Biden was Vice President.

Jay Clayton, the former chair of the Securities and Exchange Commission, appeared at a hearing hosted by the House of Representatives Select Committee on the Chinese Communist Party that is studying whether China poses a risk to US financial stability. Clayton proposed that companies with market capitalizations above $50 billion or with China-based revenues or costs above $10 billion unveil their exposure to the world’s second biggest economy and explain how their operations would be affected in the event of a disruption in US-China economic ties. This could impact a number of large US technology and finance companies and is another example of how China is becoming an uninvestible region.

Simon & Schuster released a new, and some say scathing, book by Walter Isaacson on Elon Musk. Automakers and the United Auto Workers union are quickly approaching a Thursday night deadline to reach a deal, or 146,000 autoworkers could go on strike. North Korean leader Kim Jong Un visits Russia to demonstrate the “strategic importance” of the two countries’ relations (and possibly to cut a deal to supply arms to President Putin). Morocco struggles to reach survivors from a recent earthquake that to date, has a death tool of nearly 3,000 people. At least 10,000 are missing in Libya after floods caused by a huge Mediterranean storm swept away a quarter of the eastern coastal city of Derna. Apple, Inc. (AAPL – $176.30) launched a new series of iPhones that include a new titanium shell, a faster chip, and improved video game playing abilities.

Inflation Matters

And despite all of this, the big story of the week will be inflation data. The CPI will be released Wednesday, the PPI on Thursday, and import/export prices on Friday. This week’s inflation data reports on the month of August, but we would point out that while headline inflation has been moving steadily lower for much of this year, energy prices have done likewise. However, after eight consecutive months of year-over-year declines in energy prices, WTI oil futures are up 10% YOY in September, to date. Fortunately, or unfortunately, the technical chart of WTI oil futures looks favorable and this suggests gains could continue in the weeks ahead. If they do, it would be a bad sign for September’s headline inflation number. A rebound in inflation could upset not only the consensus view of inflation, but Federal Reserve policy for the rest of the year. See page 3. In sum, we would not become complacent about inflation, and neither should the Fed. But according to a Reuters poll, the Federal Reserve will leave its benchmark overnight interest rate unchanged at the end of its September 19-20 policy meeting and probably wait until the April-June period of 2024 or later before cutting rates. In our view, next week’s FOMC meeting could bring some surprises.

The charts on page 4 are not new to readers, but they are important since they show that whenever inflation reaches a peak level like the 9% seen in June 2022, inflation has declined, but in concert with higher interest rates and a recession. Tighter monetary policy has been key to reducing inflation, and the tightening cycle typically ends with a real fed funds rate of at least 400 basis points. This suggests that even with a 3% inflation rate a typical fed funds rate would be 7%. And even if a 7% rate does not materialize, it does suggest that the fed funds rate is likely to move higher in September. We would not be surprised if it did. However, the CPI data for August is apt to set the tone for the next week and it will not include the recent rise in energy prices.

Household Haves and Have Nots

Quarterly data on household finances from the Federal Reserve shows that the net worth of households and nonprofits rose $5.5 trillion to a new record high of $154.3 trillion in the second quarter of the year. This increase came from a $2.6 trillion increase in the value of equities held directly and indirectly and a $2.5 trillion increase in the value of real estate. Keep in mind that not all households own equities or real estate, and therefore these increases accrue disproportionately to the wealthier households who benefited from rising stock and real estate prices.

The same release showed that household debt increased at a 2.7% annualized rate in the quarter to $19.6 trillion. Household equity ownership increased from 25% of total household assets to 25.6% of total assets at the end of the second quarter. This ratio peaked at 29.2% in June 2021, which was just ahead of the January 2022 market peak. See page 5.

The Federal Reserve released new monthly data on consumer credit. Consumer credit made headlines recently when credit card debt exceeded $1 trillion for the first time. July’s numbers show that consumer credit continues to grow but at a decelerating rate. Whereas revolving credit grew at a 16% YOY pace in January, this dropped to a 10% YOY pace in July. See page 6. Credit card debt rose as the savings rate declined this year which could be a sign that household finances were becoming stretched. Retail sales also slowed in 2023 despite the pent-up demand in the auto sector. In general, we expect credit balances to decelerate further given that the interest rate on credit cards rose from 16.65% in July 2022 to 22.16% by July 2023.

Income and poverty data released by the US Census Bureau this week showed the child poverty rate — based on a supplemental measure that adjusts for government benefits and household expenses — jumped from 5.2% in 2021 to 12.4% in 2022. The supplemental poverty rate rose from 7.8% in 2021 to 12.4% in 2022. The official poverty rate was largely unchanged from 2021 at 11.5%. Nevertheless, family incomes failed to keep up with a 7.8% jump in consumer prices that was the largest since 1981 and real median household income fell by 2.3% to $76,330 in 2022. According to Census officials, this was about 4.7% below 2019.

Technical Update There has not been much change in the last week after the three major indices rebounded from their 100-day moving averages and the Russell 2000 bounced up from its 200-day moving average. Overall, the near-term trend appears indecisive. Even if the rally moves higher, unless all the indices exceed their all-time highs (which we doubt), the longer-term pattern remains characteristic of a long-term neutral trading range. See page 9. The 25-day up/down volume oscillator is at a negative 1.03 reading this week, relatively unchanged from a week ago, and at the lower end of the neutral range. See page 10. The 10-day average of daily new highs is 103 and the new lows are 91. This combination tilts slightly positive this week with new highs above 100 and new lows below 100, but not convincingly so. In sum, the broad trading range market continues and is best represented by the Russell 2000 with support at 1650 and resistance at 2000.

Gail Dudack

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So Far September is Living up to its Reputation

DJIA:  34,500

So far September is living up to its reputation – it’s the year’s worst month.  A bit of a surprise given last week’s positive action, and this September actually has a couple positive aspects.  A down August is often followed by a good September and pre-election years also favors more positive outcomes.  Try though you might, it’s hard not to think it’s Tech’s world.  Everyone couldn’t wait for the pullback in Nvidia (462), and now what?  Apple (178) is “own it don’t trade it” until China bans the iPhone.  The market is in another little correction phase, and as always and forever – news follows price.   Need now is for the market to start ignoring some bad news, like Apple’s and rates, and to get back to a pattern of positive A/Ds.  Meanwhile, Tech is just fine when it comes to what we call “retro Tech” like IBM (148), Oracle (125), Cisco (57), and best of all recently, Dell (69).

Frank D. Gretz

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US Strategy Weekly: September’s Record

September has a poor reputation for equity performance and for good reason. The month ranks last in terms of price performance and has generated declines in the S&P 500 index in 50 of the last 91 Septembers. It is the only month that has closed with price losses more than half the time. The historical record shows that since 1931, September produced an average loss of 1%. The average decline narrows to 0.7% in all years since 1950.

We think there are a number of reasons for this weak performance. First, September does not have the positive liquidity factors that November, December, and January have in terms of IRA funding, tax-loss selling and reinvesting. Nor is it a fiscal year end for most pension funds or mutual funds which usually provide portfolio inflows and readjustments. On the other hand, it is a time when investors look ahead to next year’s earnings, economic, and/or political forecasts and this is often murky. Stocks do not like uncertainty. This September includes a number of events that could move stock prices, such as the G20 New Delhi summit September 9-10, the FOMC meeting on September 19-20, a potential government shutdown October 1, and the impact of Saudi Arabia and Russia extending the oil cuts until year end. Given that the equity market is currently trading at an estimated 2023 PE of 20.3 times, there is little room for disappointment. We remain cautious but believe the equity market remains in a wide neutral trading range best represented by the Russell 2000 between support at 1650 and resistance at 2000.

Narrow is Not Noble

The Nasdaq’s weekly digest called Smart Investing had a table of stocks it called the “magnificent seven” that has been leading the Nasdaq Composite index and S&P 500 higher in recent months. Not surprisingly, it includes stocks such as Apple Inc. (AAPL – $189.70), Microsoft Corp. (MSFT – $333.55), Alphabet Inc. (GOOG – $136.71), Amazon.com (AMZN – $137.27), NVIDIA Corp. (NVDA – $485.48), Tesla, Inc. (TSLA – $256.49). and Meta Platforms, Inc. (META – $300.15). See page 3. From this table we see that these 7 stocks represent 40.43% of the Nasdaq Composite and 30.625.637% of the S&P 500. Apple and Microsoft represent nearly 21% of the Nasdaq Composite and nearly 14% of the S&P 500 and these two stocks have had year-to-date gains of 46% and 39%, respectively. However, it is NVIDIA, Meta Platforms, and Tesla that have been the biggest drivers of the indices with outsized year-to-date gains of 232%, 149%, and 108%, respectively.

The problem with a narrowly driven rally is that it forces portfolio managers to own these stocks in order to perform in line with the benchmark averages. In the longer run this means the market becomes more and more momentum driven and less driven by value. This can persist for a long while much like the bubble market in 1997 to 2000, but the eventual decline in the averages becomes greater the longer stock prices are based upon momentum rather than earnings.

August Payrolls

The pace of job creation came in slightly ahead of expectations at 187,000, but July’s number was revised down by 30,000 to 157,000 and June’s payrolls were lowered by 80,000 to 105,000. These are very large downside revisions, and it gives rise to questions about BLS statistics. The unemployment rate rose from 3.5% to 3.8% which materialized not just from the 514,000 newly unemployed, but also from the 736,000 increase in the civilian labor force. See page 4. We wonder if this increase in the labor force is a result of financial pressure experienced by many households and the need for an additional paycheck. We see other signs of stress in consumer finances. According to the credit agency Equifax, credit card delinquencies have hit 3.8%, while 3.6% have defaulted on their car loans. Both figures are the highest in more than 10 years.

Yet, despite the declining trend in employment growth, the establishment survey shows jobs grew 2% YOY, above the average rate of 1.69%. The household survey showed employment growth of 1.76%, also above the long-term average of 1.51%. In short, neither are at negative-growth recessionary levels.

Personal income grew 4.7% YOY in July and real personal disposable income increased 3.8% YOY. RPDI growth is down from 4.9% in June, nevertheless, it is the seventh consecutive month of real gains in income. At the same time, personal consumption expenditures grew 6.4% YOY in July, primarily from an 8.3% increase in services. Durable goods expenditures rose 4.5% YOY and nondurable spending increased 1.8% YOY. In general, the post-pandemic stimulus-driven economy appears to be fading. See page 6.

Strains in household finances can also be found in the savings rate. After hitting a peak of 26.3% in March 2021, it fell from 4.3% in June to 3.5% in July. Higher interest rates are also taking a toll on savings and spending. Personal interest payments rose 49.4% YOY in July, down from 55.3% in June, yet still increasing at a record rate. Personal interest payments were $506 billion in July after averaging $330 billion in 2018 and 2019. This is a huge jump in interest payments. See page 7.

Watching oil

The United States has stopped selling oil from its Strategic Petroleum Reserve (SPR) and has begun to buy oil in order to replenish this important reserve which is at a multi-decade low. Meanwhile, despite a rally in the oil market and analysts’ expectations of tight supply in the fourth quarter, Saudi Arabia and Russia said they would extend voluntary oil cuts to the end of the year. These two events are sparking a breakout rally in oil which could jeopardize the consensus view that inflation is trending lower. And as we already noted, the White House has called on Congress to pass a short-term “continuing resolution” to keep the government funded past Sept. 30 and to avoid the fourth shutdown in a decade. This is impacting the fixed income market. The 10-year Treasury yield bounced back up to 4.27%, closing in on the important 4.33% resistance level. See page 9.

Technical Update

The S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite, are rebounding from their 100-day moving averages and the Russell 2000 is bouncing from its 200-day moving average, but the near-term trends are indecisive. Unless, or until, all the indices exceed their all-time highs (which we doubt), the longer-term pattern remains characteristic of a long-term neutral trading range. See page 11.

The 25-day up/down volume oscillator is at a negative 1.79 reading this week, relatively unchanged from a week ago, and at the lower end of neutral. The oscillator generated overbought readings in 10 of 22 trading sessions ending August 1. However, none of these overbought readings lasted the minimum of five consecutive trading days required to confirm the advance in the averages. Strong rallies should also include at least one extremely overbought day which was also missing.

As this indicator approaches an oversold reading of minus 3.0 or less, the same will be true – five consecutive trading days in oversold would confirm the decline. See page 12. Another sign of the market’s longer-term neutral trend is found in the new high/new low list. The 10-day average of daily new highs is averaging 93 and new lows are averaging 77. This combination reverts from negative to neutral this week since both new highs and new lows are below 100.

Gail Dudack

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It’s About Stocks … More Than the Stock Averages

DJIA:  34,721

It’s about stocks … more than the stock averages.  While the focus is always on the market averages, typically it’s the average stock that tells the story.  When they began to diverge even a bit back in July, it set the stage for the recent little correction.  It has been easy to call the recent weakness a bull market correction, but you never know.  When the S&P has spent close to 100 days above its 50-day average, the first break is just that – a bull market correction and only about 6%.  When last week’s numbers saw close to 50% of stocks at a 30-day low but only 4% at a 12-month low, that says correction in an uptrend.  Relatively muted selling is one thing, needed is a revival in buying, making this past week a good one.

Beginning in the second week of July the market hit a real dry spell – eight consecutive days of negative A/Ds, 10 of 11 in all.  Downtrends happen, the real damage technically was when three of those days saw the market averages higher. This sort of divergent action can go on, but it never ends well.  This pattern changed last week when finally there was a buying interest, a day with almost 4-to-1 up.  One up day will never make a difference and, indeed, some of the best up days have occurred in bear markets.  That day, however, was followed by a couple of days with 3-to-1 up and Tuesdays surprising 5-to-1 up day.  This makes the correction likely over, though the usual caveats apply.

We have suggested Nvidia’s (494) “sell on the news day” was not a complete surprise, though you never like to see the market ignore good news.  In this case it seemed not that expectations were too high, rather enthusiasm was too high.  It was the euphoria that needed to be corrected, and the surprise weakness seems to have done so.  Now that the dust has settled, what remains is a technically good pattern, and Tech generally has improved.  What have been good charts all along, however, have been those stocks like Quanta (210), Roper (499) and Ingersoll Rand (70), among others.  The group with the greatest number of stocks above their 200-day is Oil, though no one seems to care.  And when was the last time you thought about Uranium (24)?  Meanwhile, Retail is weak to the point of being worrisome.  Banks are another problem, but one that’s known.

Too big to fail, but too big to be saved.  That’s how the Chinese real estate market has been described.  Then, too, there isn’t much anywhere about China that can be construed as positive.  According to the Bloomberg database of news articles, there has never been a week with more negative articles dating back a decade.  Not surprisingly the Shanghai Composite hit new lows recently, accompanied by extreme oversold readings.  Oversold doesn’t mean over, but similar past readings have resulted in a rebound.  China always seems able to stimulate its way out of these problems, though doing so always becomes more difficult. We’re not fans here, but we would point out that the charts of individual charts are not as bad as you might think – they’re trading ranges.  Like it or not China matters, problems in China rarely stay in China.

Not long ago we wrote the odds of getting a good Tech report was slim to none.  Now that seems to have changed, not just with Nvidia but even this week with the DJ component Salesforce (221), OKTA (84) and CrowdStrike (163).  The favorable responses here could be about the reports per se, but we tend to think it’s about the market – in this case it’s the market that made the news.  At the very least, the market isn’t ignoring good news, another sign the correction is likely over.  This and the change in the A/Ds argue for higher prices.  It is a seasonally weak period, but something you hear almost too often.  Moreover, it’s not such a big deal in pre-election years.  It may not be straight up, but up provided we stay away from those bad up days – up in the Averages but with poor A/Ds.

Frank D. Gretz

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US Strategy Weekly: Beware What You Wish For

US job openings in July dropped to the lowest level in nearly two and a half years and equity investors rejoiced. The news triggered a 292.69-point gain in the Dow Jones Industrial Average, carrying the index just 5.3% below its all-time high of 36,799.65 high and to a gain of 5.1% year-to-date. The JOLTS report also showed that the number of people quitting their jobs fell to the lowest level seen since early 2021, which implies jobholders feel that switching jobs has become more difficult. More importantly, the employment report for August will be released at the end of this week and it too could be a market-moving event, particularly if it confirms a below-consensus increase in jobs. However, we would be wary of being bullish about bad economic news since bad news inches the economy closer to a recession and a recession has never been good for corporate earnings or for equity prices.

We have often noted that high inflation has a debilitating impact on consumer purchasing power, corporate profit margins, and price-earnings multiples. It erodes the value of the dollar and of savings. In short, it is bad for all parts of the economy. And this is why we believe the Federal Reserve is likely to be more hawkish than dovish for all of 2023. In our opinion, the Fed understands that an inflation target of 2% will not be that easy to achieve without slowing the economy down. And while Fed Chairman Jerome Powell has danced around the question of whether a recession or no recession is part of the inflation solution, slowing inflation without a recession would be like threading a tiny needle … possible but difficult. 

History shows that whenever inflation has had a rapid rise or has been more than a standard deviation above the norm (6.5%+), like the 9% seen in June 2022, it has always been followed by a recession. A recession is most often the result of tighter monetary policy which has generally ended with a real fed funds rate of at least 400 basis points. Perhaps it will be “different this time” but that is a risky view, in our estimation. See the historical charts on page 3.

For the real fed funds rate to reach 400 basis points today, with a 3% inflation rate, means the fed funds rate would rise to 7%. We are not predicting a 7% rate, but we do believe the fed funds rate is likely to move higher in September and this would be a negative surprise to the consensus. It could also be a dampener to economic activity in the months ahead.

Is Bad News Good News?

In line with the JOLTS report, the regional Federal Reserve activity reports were a mixed bag. The Kansas City Fed Manufacturing Survey was at zero in August, but up from negative 11 in July. The Philadelphia Fed Nonmanufacturing Survey was negative 0.5 in August, down from 2.0 in July. The Richmond Fed Manufacturing Survey was negative 7.0 in August, up from negative 9.0 in July. The Chicago Fed National Activity Index was 0.12 in July, up from negative 0.33 in June. The Texas Manufacturing Outlook Survey was minus 17.2 in August, up from minus 20.0 in July. All in all, these surveys were not a recessionary package, but neither were they a sign of strength.

As interest rates rise the biggest impact may be seen in the housing and auto sectors, two areas that have been a source of strength since the pandemic. New home sales rose 4.4% in July to 714,000, an increase of 31.5% from a year earlier. The median price of a single-family home rose 4.8% in the month to $436,700, but this was down nearly 9% YOY. Home prices and sales have been relatively stable, but primarily due to a lack of inventory. The supply of existing family homes rose fractionally in July to 3.2 months, nevertheless, this is a historically low level. While low supply has been what has supported the residential market, we worry that demand may eventually fall as a result of high prices and interest rates. See page 4. Rising mortgage rates are already hurting housing affordability, which is currently at its lowest level since 1985. This is a concern since housing typically represents 15% to 18% of GDP. See page 5.

The auto industry is also hurt by higher prices and rising interest rates. The post-pandemic auto-buying surge is over, yet vehicle sales rose in July to 16.3 million units. See page 6. However, this remains well below 17-18 million units consistently seen between 2014 and 2020. Autos, along with housing, have been the most unwavering drivers of the US economy. We will be watching closely to see if higher financing rates slow auto sales.

Consumer sentiment can be a guiding indicator of the economy at both peaks and troughs, so it is worth noting that August’s deterioration in sentiment surveys follows months of steady improvement. The University of Michigan consumer sentiment index fell in August, dragged down by future expectations due in large part to rising gas prices. It was the first month-over-month decline since May for this survey. The Conference Board consumer confidence index fell from 114.0 to 106.1 in August as both present conditions and expectations fell significantly. See page 7. We had been hopeful that the improvement seen in real wages in recent months would give a boost to investor sentiment and consumption, however, we may have been too optimistic.

Important economic news will be released this week including the Fed’s favorite inflation benchmark, the personal consumption expenditure deflator. It will be released alongside personal income and real personal consumption for July. Pending home sales may give an insight into whether higher mortgage rates are taking a toll on home buyers. And the week ends on Friday with the employment report, the ISM manufacturing report, and vehicle sales for August. This should give good insight into economic activity and the health of the consumer.

Technical Indicators

The Dow Jones Industrial Average, the S&P 500 index, and the Nasdaq Composite index have all tested their 100-day moving averages and are rebounding. This is favorable. The Russell 2000 index tested its 200-day moving average and is also rebounding. We would rate these tests as tentatively positive; but even if successful, the longer-term pattern remains characteristic of a long-term neutral trading range. See page 9.

The 25-day up/down volume oscillator is at a negative 1.10 reading this week, relatively unchanged from a week ago, and at the lower end of its neutral range. This oscillator generated overbought readings in 10 of 22 trading sessions prior to August 1. However, none of these overbought readings lasted the minimum of five consecutive trading days required to confirm an advance in the averages. Strong rallies should also include at least one extremely overbought day which was also missing. However, it is also important to note that the recent rally did not generate new highs in the indices. In short, the recent rally is, to date, an advance within a larger neutral trading range. That is what this indicator has been implying for over twelve months. In our view, this trading range is a substitute for a bear market, and it is likely to persist until inflation is under control and/or earnings growth becomes more predictable and stable.

Gail Dudack

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If it’s a Low … Is it an Uptrend? 

DJIA:  34,099

If it’s a low … is it an uptrend?  They may seem the same, but they are not always so.  By historical standards a low should be close – bull market corrections typically fall in the 6% range.  The S&P has taken out its 50-day, as have most of the Averages, but this says little more than we are in a correction phase.  What does seem consequential is that the S&P had remained above its 50-day for close to 100 days. This sort of trend doesn’t happen in bear markets.  When the trend does end, on average the correction again tends to be about 6%.  We don’t really like data like this because often there’s “always something.”  Suffice it to say for now the weakness seems normal, if there is such a thing.  The rub comes in the new uptrend.  After breaking the 50-day sorting things out typically takes a month or so, new highs usually come a couple months later.  Even market lows can be a process.  

Banking may be a fine profession, it’s the bankers that give us trouble.  If not lending to Third World countries, or to see-through office buildings, they’re trying to rig LIBOR.  For now it’s the Regionals that are between a rock and a hard place.  They’re caught in the equivalent strategy of buying High, selling Low, and making it up on volume – a strategy we’ve tried with stocks from time to time.  Of course it’s not like rising rates were a big secret, and isn’t rate stuff what banks do?  What is done is done but not without some implications for the overall market.  There are a lot of banks and that has implications for market breadth, that is, the A/D Index.  It also helps explain why the Russell 2000, what we call love among the rejects, acts as badly as it does.  It’s 20% Regionals.

One non-reject in the Russell happens to be its largest holding, Super Micro Computer (263).  By our calculation, back in early August SMCI had outperformed Nvidia (472) year-to-date, then came the collapse – a 50-point downside gap, followed by an additional 50-point decline.  In Tech land, things sometimes change fast.  And things seem to be changing yet again. You can argue the overall uptrend was never threatened, and it was a much-needed correction, as they like to say.  What seems important in the here and now is the stock has re-taken the 50-day.  Buying stocks in overall or long-term uptrends is best.  When they correct, however, you never know.  Best to buy some if you must, and the rest when they retake the 50-day.

Tech gets all the attention, rightly so since they are what got us here, bull market-wise.  It is a bit ironic, however, that with the exception of Nvidia few Techs have been above their 50-day recently.  Meanwhile, the seemingly forgotten Oil shares have cycled from fewer than 15% above their 200-day to more than 90%.  This kind of momentum change has resulted in higher prices more than 80% of the time.  Then there are the unscathed, the stocks which have come through the correction with little or no damage.  Everyone likes to buy bargains, but often the stocks that give up little are those that lead in the next phase of rally.  We’re thinking here of stocks like Quanta (201), Eaton (221), Ingersoll (68) and Roper (489).  In Tech, Arista (179) has a pattern we particularly like – gap up and a high-level consolidation.

That Thursday was a “sell on the news day” was not completely surprising.  If more than just that it would be surprising, and not good.  We’ve been waiting for the market to ignore bad news, and there have been hopeful signs.  For sure, good markets don’t ignore good news.  Wednesday’s 3-to-1 up day, the first in more than a month, also was encouraging.  However, one day is just that, what is needed is a pattern of better A/Ds, especially on those days when the Averages are up.  Stocks aren’t cheap, rates are rising and Powell’s speech at this time last year took the market down some 19%.  A recovery is not guaranteed, but despite Thursday seems likely.  The S&P’s duration above the 50-day suggests this remains a bull market correction.

Frank D. Gretz

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US Strategy Weekly: Fed Minutes – Inflation is Unacceptably High

Fitch downgraded its credit rating for long-term US government securities from AAA to AA+ on August 1, 2023, citing an erosion of fiscal governance and rising general government deficits. Moody’s cut the ratings on 10 mid-sized lenders on August 8th. The Fitch Ratings service warned of a downgrade on more than a dozen banks on August 15th and S&P Global Rating downgraded five regional banks on August 21st, focusing on lenders with commercial real estate exposure. All these rating agencies indicated that some banks face a future risk to their balance sheets due to potential bad debts in the commercial real estate area, but all banks are dealing with liquidity pressure since many portfolios are drawing interest income of 2.5% to 4.5%, while needing to pay depositors 4.5% to 5.5% in savings and money market accounts. This may seem like an isolated problem within the banking sector, but it is not. Although there is no immediate crisis in the banking sector, there are strains in the system that are likely to continue longer than some expect. More importantly, the US economy cannot do well if the banking sector is not doing well. It never has. So, in our view, with this backdrop, it is not surprising that stock prices have been in a correction in August.

Trading Ranges Defined

The last year has produced a series of issues that have chastened both optimists and pessimists. From a longer-term perspective, the last 18 months have been frustrating for both the bulls and the bears. Our long-held view is that the stock market is in a broad sideways trading range, best defined by the Russell 2000 between support at 1650 and resistance at the 2000 level. The other indices have less obvious trading ranges, although it is clear that price action has been contained by resistance at the January 2022 peaks and support at the October 2022 lows.

Long-term trading ranges are not unique in equity history, but they have not materialized in a while. Since the March 2009 low, equities have been in a relatively consistent uptrend. In short, for most of the last 14 years, stock prices have been “trending” and as result, new investors might be unfamiliar with rallies that have limited leadership and declines that lack follow through. However, trading ranges are not unusual, and in our view the current trading range is a substitute for a more dramatic bear market.

Classic bear markets are often triggered by an unexpected event that shakes investors’ confidence and this event becomes the catalyst for an unforeseen earnings decline. A dramatic bear market ensues and produces a relatively sudden but quick repricing of risk. A trading range is simply another way of repricing risk and can be a subtle substitute for a bear market.

In the current environment, a trading range is a way for earnings to catch up with prices. Earnings for the S&P 500 declined on a year-over-year basis during the second, third, and fourth quarters of last year. Earnings are now expected to grow modestly from these much-reduced levels; nevertheless, the outlook for earnings growth remains uncertain.

If we look at S&P Dow Jones operating earnings data, it shows that the four-quarter sum in earnings peaked in March 2022 at $210.16. The S&P Dow Jones consensus estimates show that four-quarter earnings could reach a new high by the end of the 2023 third-quarter earnings season, with earnings of $212.89. However, these are estimates and data shows essentially no earnings growth for most of 2022 and 2023. In sum, prices moved higher in 2023, but the fundamentals did not. The recent trading range is a way for earnings to eventually catch up with stock prices. In our view, the catalyst needed for stocks to break out of this trading range is for the Fed to successfully tame inflation and this will take more time. In the interim, we believe focusing on stocks with reliable earnings streams and reasonable PE multiples will be the best way of managing through this environment. 

FOMC September 20

One reason to believe the Federal Reserve will keep interest rates higher for longer is that they were so late to address the inflation problem. As seen on page 3, in previous cycles, the fed funds rate typically increased ahead of, or in line with, the level of inflation. In this cycle, the Fed was 12 to 18 months behind the inflationary trend, and this allowed inflation to become ingrained in the service sector. Since service sector inflation is less commodity driven and more salary driven, it is more difficult for the Fed to control. It also explains the Fed’s attention to service sector inflation. Meanwhile, it is important to note that the real fed funds rate usually reaches 400 basis points in a tightening cycle, and though the real rate has been rising, it is now only at 230 basis points. In short, we believe another rate hike is likely on September 20 and we do not believe this is discounted in stock prices.

The path of interest rates is important to the economy since it will impact both the auto industry (see page 4) and the residential housing market. The National Association of Home Builder Confidence index fell from 56 to 50 in August, which is not surprising, since the June NAR Housing Affordability index fell from 93.7 to 87.8, the lowest level since January 1984. This decline in affordability was before the Fed’s July rate hike! The June decline was attributed to a combination of median family income ratcheting down to $91,319, the median price of a single-family home rising to $416,000 and the NAR mortgage rate increasing 28 basis points to 6.79%. See page 5.

Although the housing market has been in a slump for almost two years, it is possible that housing is about to slow further as interest rates rise and remain high. This risk can be seen in the fact that both existing and new home prices have stopped increasing and in recent months have registered year-over-year declines. Also interesting is the fact that home prices and retail sales have been highly correlated over the last 60 years, and both appear to be on the cusp of a negative cycle. See page 7. Some may think that these are reasons for the Fed to pause, but underlying these risks are a tight labor market and wage growth that recently has exceeded the pace of inflation. We believe the Fed will remain higher for longer in order to be confident that inflation will reach its target of 2%. 

Technical Update

As a result of the recent weakness in the equity market, all the popular indices are currently trading below their 50-day moving averages and are about to test their 100-day moving averages. However, the Russell 2000, is about to test its 200-day moving average which is now at 1843. We would not be surprised if all these moving averages were broken in the near term since this would be typical of a long-term neutral trading range environment. See page 9. 

The 25-day up/down volume oscillator is at negative 2.05 this week, which is at the bottom of the neutral range. It is close to registering an oversold reading of negative 3.0 or less, which would neutralize the recent unsustained overbought readings. Meanwhile, the 10-day average of daily new highs is 54 and new lows are 111. This combination turned negative this week since new highs fell below 100 and new lows rose above 100. All of the above is normal for a trading range market.

Gail Dudack

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The Correction…

DJIA:  34,413

The correction has been more than expected – or perhaps just different than expected.  While just a few percent in the S&P, it has hit the seemingly unstoppable Tech the hardest.  Best to be wary when they start giving things a name – one-decision stocks, dot-com’s, Magnificent Seven.  What’s done is done – now a couple things need to change.  Good markets ignore bad news, this market has ignored some market friendly news – the Jobs number, and more recently the CPI.  The market has to start ignoring bad news.  More importantly, the spate of recent days with the Dow up and the A/D’s flat or down needs to not only change, it needs to reverse.  More than any level in the Averages, what’s needed is a sign of a buying interest, a couple of days with 3-to-1 up.

Frank D. Gretz

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