Bearish Engulfing
“I’ve always wanted to see a bear in real life.”
—Cocaine Bear
OK, what’s next?
Key takeaway: The recent capital allocation away from mega cap tech begs the question whether the top is in. The Beige Book paints a portrait of a weaker consumer and businesses facing falling pricing power. That finding is consistent with Pave models’ high ranks for stocks with strong working capital ratios that can withstand declining revenues. Historically, that occurs late in the cycle and coincides with a Fed rate cutting campaign. Critically, a stronger Yen and a massive Yen carry trade unwind could come right on time, which is at the worst time for vulnerable asset markets.
All or Nothing Dept: I believe we have begun the equity top, but even if that is the case, there will be a rebound. The level from which that rally starts, and its characteristics, will determine equity positioning for the rest of the year.
What many investors get wrong is that no matter how good one’s analysis is, no one knows the future. That means that while I am convinced that we have started the topping process, I cannot rule out a move as high as 5800 in the S&P 500. It is not my base case—however, my base case was a 5450 max target, and that was exceeded neatly by this rally.
The following is what I wrote last week in the Markets section, but I am leading with this due to its relevance: I had mentioned ?“While it is tempting to go short on the fulfillment of so many extended targets, it has paid to not anticipate reversals but wait for a break of support.“ As support levels break, begin to reduce exposure. We should see a reversal higher this week, either from Friday’s lows or a bit lower—see Equities section for actionable levels.
With a good deal of certainty, the tables have turned. Yet, the key thing to remember is you must let the market tell you when it has turned. All the market has said so far is that it is turning, but that process may take months.
Beige is my favorite color?
The Fed’s Beige Book for July was significant because Jerome Powell and other Federal Open Market Committee (FOMC) voters are worried about the recent weakness in the labor markets. The 12 district banks reported employment was “flat or up slightly,” which does not bode well for nonfarm payroll growth in the coming months. The overall take was that “Expectations for the future of the economy were for slower growth over the next six months due to uncertainty around the upcoming election, domestic policy, geopolitical conflict, and inflation.” This data was collected into July 8, so it reflects a current state of a broad array of businesses.
This data is presented to the FOMC participants for their July 30-31 meeting, and supports the view that management is no longer interested in retaining workers at all costs because the previous situation of a tight labor supply no longer exists. The 12 district banks noted a “slowing of wage growth due to increased worker availability and less competition for workers.” This elemental change in the employment dynamic means payrolls will fall with sales.
Against a backdrop of slower wages, there was a broad agreement nationwide that a marked slowing in the consumer has occurred, with “almost every District mentioning retailers discounting items or price-sensitive consumers only purchasing essentials, trading down in quality, and buying fewer items.”
The Beige Book’s more negative view of the consumer should not have any impact on the outcome of no rate change at the July FOMC decision. However, it is adding to the momentum to the Fed’s shifting focus from inflation to softer growth.
Revenues are tied to pricing power, and earnings estimates have been ignoring the initial warning signs coming from the labor markets. Any deteriorating forecast of consumer spending will be a major fundamental swing factor that would sustain a market selloff.
A non-economic factor that would also drive a selloff could be any reversal of asset flows sparked by a strengthening Yen, as discussed below.
The Yen Carry Trade Unwind: Which Came First, the Niwatori or the Tomago?
The quarterly chart below of the Dollar-Yen exchange rate (USDJPY) over the last 50 years shows an interesting cyclical relationship shown by the vertical lines that suggests a top in the currency pair:
Remember that 4 small bars is equal to 1 trading year. I will emphatically point out that the 17-year cycle turns in USDJPY from Q2 1973, 1990, 2007, and 2024 are also major equity turning points. One could argue that the Yen strengthened due to a risk off environment, or, perhaps, equities fell due to Yen strength, but the bottom line is that these 17-year swing cycles of Kondratiev long waves portend a prolonged period of economic contraction.
OK, I realize that most believe this class of analysis is as credible as crop circles and Chariots of the Gods myths, but there are some legitimate factors behind this Yen cycle playing out.
First, here is a 2-year forward implied interest rate differential chart courtesy of Societe Generale, showing that the expected gap in 2026 between Japan’s Overnight Call Rate and the Fed Funds rate is trading at levels that should put USDJPY currently?in the mid- to high 140’s, a drop of roughly 7% versus current USDJPY levels:
The consensus is for the Bank of Japan should be raising rates into 2026 as the Federal Reserve is lowering rates, and the next chart emphasizes why the BoJ will shed its rate cutting inertia:
Note the highlighted portion at the left on the above chart. The last time the BoJ raised rates, and the last time we saw a yen carry trade unwind was…17 years ago.
Wednesday night is slated for the release of Tokyo core CPI which peaked at 3.1% in March 2024 then plunged to 1.2% in May and was last reported at 1.4% for June. Any surprise to the upside will have an impact on USDJPY. The next BoJ rate decision is out July 31, which is a Tuesday night before the FOMC statement/press conference due to the time difference.
Markets:
Equity Market: IWM surge remains key
Weekly Trend: Bullish
I wrote last week that for the coming week the Russell 2000 ETF IWM is a major focus, and mentioned it was possible “IWM could rally another 7% toward 232.” As it played out, it rallied to 227 on Wednesday before reversing down 5%.I also mentioned that “if IWM races higher, I cannot rule out an eventual 4-5% rally in the S&P.” The S&P 500 Index did move higher, but by only 1.5%, and on Wednesday morning when IWM saw a new high, the S&P 500 gapped down in a stark display of negative divergence:
There are three important dynamics at play:
Additionally, last week’s price action exceeded the range formed during the prior week, meaning there was a higher high and a higher low that was reached last week. I have labeled three earlier weekly “bearish engulfing” bars (see red “BE”) along with my proprietary sell signals based on the National Association of Active Investment Managers Exposure Index (see black arrows) on the weekly S&P chart
The Quarterly Refunding Announcement played a pivotal role in adding force to the selloff one year ago (see the first QRA at the end of July), and we potentially have another such event arriving in less than two weeks from now.
Weekly S&P update using Elliott Wave
The following chart was displayed last week because there were no less than a cluster of 6 resistance levels on the S&P 500. Thanks to IWM’s continued gravitational pull as it moved into orbit, the S&P hit the upper resistance levels at 5670 before reversing. I had two major levels on the downside: “a break below 5575 that is followed by a move below 5450 is a topping signal.”:
领英推荐
The S&P broke below 5575 but did not break the major 5450 support. I am also looking for any further bearish action to hold at 5500 initially. The Elliott pattern is a classic, and screams top, but the extreme of the move is 5800 (see “C upper” in green above). Additionally, use 19,600 as NDX support in the cash index for this week, bullish above, negative below.
IGV
I have featured the software ETF in earlier commentaries, and it rallied after a breakdown in late April and just formed a double top below 89. Any new highs above 89 increase the odds of a sustainable rally in the broad indices. For now, it is forming a major distribution top.
AAPL
Finally, at the stock level, a move above the 229-235 gap resistance zone would coincide with a break above 89 in IGV and be a bullish signal for the general uptrend in stocks to resume. For AAPL watchers, 232 is a potential zone to bounce into and then reverse lower. If we see weakness to start the week, many will be setting AAPL sell stops below 222, pushing AAPL and the NASDAQ 100 lower.
Fixed Income: New week, same support
Weekly Trend: Bullish but overbought
The weekly 2-year yield is getting close to major 4.05% cloud support:
The fixed income market is getting quite close to that 4.05% key level in the short end. That level looms large given the volatility to come in the aftermath of Friday’s PCE inflation data and the following Wednesday’s FOMC and Quarterly Refunding Announcement.
The daily 10-year yield chart continues to show lower highs and lower lows, but the 4.20% area is continuing to show support, and the trend model flipped up (short Treasury notes):
The daily chart show that the bears need a push in yields first above 4.33% this week and eventually a close back above 4.50% to change the trend.
Crude Oil: Staying small but starting big
Weekly Trend: Bullish
The longer weekly chart below continues to stay on a bullish trend signal, but has made another weekly high below the high of the prior week:
The 240-minute intraday WTI futures chart shown last week is updated below. I had mentioned:
The rally has unfolded in 3 waves, and it needs to push above last week’s $83.75 highs before it breaks below $80.75.
The updated chart below shows the inability last week for futures to move above $83.75 and the ultimate break below $80.75.
I had concluded last week “A break of $80.75 support can see a pullback to $80, and perhaps as low as $77.50 before resumption of the longer-term rally.”
Because of its overlapping nature, I do not believe this is the beginning of? a major down leg in crude. That is why there is a chance that Friday’s lows hold up, otherwise the $77.65-85 area is the refined target. A break below that support targets $75.50. I am looking for a reversal in short-term charts to get long.
Best,
Peter Corey
Pave Pro Team
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