The Big Top?

“Don’t start acting sensible now”

—The Greatest Showman

The market is saying Don’t You Worry ‘Bout a Thing

Key takeaway: The S&P 500 sits at a technical crossroad, near a support level below which marks a top; but with only two more trading days before positive seasonals kick in, offering a solidly bullish risk return setup. Fixed income traders locked in on a 25-basis point cut, giving the Fed no latitude, but the PCE detail opens the door for a December pause. Watch the two-year yield if election uncertainty arises after Tuesday: it should be lower on a flight to safety, and if not, that is bad news.

“It’s the Market, Stupid” Dept: The conversation has centered around how America’s political fabric will keep profligate spending/corporate taxation/regulation in check if Harris wins or keep reckless tariffs/reduced Federal revenues from occurring if Trump wins. The hope for moderation against policy excess seems to be a split Congress. The avalanche of historical research seems supportive of this view, but we are burdened with unprecedented fiscal and monetary policy stimulus. Therefore, historical comparisons may be wrong because gridlock doesn’t deliver budget action.

This leads me to my wish for a return of the bond vigilantes. Perhaps I am nostalgic, or na?ve, but I think the markets can provide a hand brake on governmental action by raising interest rates to force Washington to take responsibility to lower the deficit. Stock valuations can also contract as a way to put guardrails around misguided public policy. Of course, inherent in such a wish is that the politicians listen to the markets.

The title of this note is to give notice to the very real possibility of a market top forming, something I will outline below. But it also alludes to the possibility of a three-ringed atmosphere if the legislative middle ground doesn’t lead the way. Let’s revisit when the dust settles.

Dallas Fed PCE Distribution

This month’s distillation of the September Personal Consumption Expenditure Price Index contains a great deal of ?information. The Federal Open Market Committee (FOMC) looks closely at the blue and green “high inflation” areas, which are the components that go into the headline number that are above 5% (blue) and above 10% annual inflation (green). As seen at the base of the chart, the total of the two categories was close to 60% in January 2024, an exceedingly elevated level, but September came in at an encouragingly low 20% (see black horizontal line).

That number, if taken by itself, would satisfy FOMC voters that inflation is no longer a problem. However, the orange 3-5% annual PCE inflation category ballooned to 35%, pushing the 3%-10+% inflationary components back near the Q2 2024 highs (see red horizontal line).

Given that the 5%+ high inflationary group has receded, the hope would be for a deflationary migration to also shrink the 3%-5% category over time. However, that 3-5% group seems to have cannibalized from more than just the high inflation category. Notice that the light blue 2-3% category has contracted, revealing that PCE inflation components also migrated higher from the 2-3% layer. This supports my view that inflation is not on a downward path toward 2% but remains sticky.

Yield curve 2’s 10s historical trigger

Assuming the market, and the Fed, start recognizing inflation’s stickiness, the 2s 10s yield curve will continue its steepening track, and push above the critical 25 basis point threshold. The monthly chart below goes back to 1989 and I added a shaded area between zero and +25 basis points, and noted the four times when the curve moved from inversion to above 25 basis points:

I overlaid those signals on the following S&P 500 monthly chart:

We have yet to cross that +25-basis point threshold, but if we do, it puts me on alert that stocks could follow through on the downside once the S&P 500 breaks below 5674.

BLS, The Conference Board, and NFIB

The only number I considered significant in Friday’s payroll data was the Bureau of Labor Statistics’ 81,000 downward revision to August’s reading, which registers now at only 79,000. This weakness was not reflected in the Conference Board’s Labor Differential that widened out nicely with the percentage finding jobs were “plentiful” rising to 35.1% from 31.3%.

The October National Federation of Independent Business Jobs Report showed weakness in the net percentage of small business employers raising compensation over the last quarter. It is approaching a region that has coincided with earlier recessions (see gray shaded areas in the chart below).

The yellow highlighted areas in the past look the same as the current decline, except they all topped near 25-30% and peaked only a few quarters before the recession. The current dynamic peaked at a record 50% based on the pandemic labor squeeze and has now just come down to levels that were considered extreme from past cycles.

I would say that if the series continues to contract toward 25%, then the recessionary probability is rising.

Bank of Japan’s Outlook

The Bank of Japan’s (BoJ) quarterly outlook for Economic Activity and Prices was released Friday. No surprises, but this chart caught my eye, specifically the rising black line showing annual scheduled cash earnings for employees:

Earnings growth was muted below 1% from 2014 through 2020, then started to rise, accelerating significantly over the past two years. The Bank noted that wage inflation is expected to

Continue increasing firmly from fiscal 2025…with labor market conditions continuing to be tight, due in part to a slowdown in the pace of increase in labor force participation of women and seniors.

Adding in bonuses, total earnings exceeded a 5% annual growth rate this year. For now, consumption is not improving sufficiently, which is holding back further rate hikes. The BoJ talks about how they must continue hiking, because even if they raise rates again, monetary policy would still be extremely accommodative based on the following chart:

I would argue that rates have been accommodative for over a decade, so we are just talking about a matter of degree. The Bank of Japan’s challenge is they must balance the potential inflationary impact of such strong wage inflation against a tepid economy. This will keep them on hold for now, especially with trimmed-mean CPI falling to half its 3.5% peak within the last year.

Markets:

Equity Market: Bulls in need of a failed breakdown

Weekly Trend: Neutral

240-Minute Emini chart that says it all is still talking

The intraday Emini chart including globex going back to the August 5 low continues to spin a good yarn.

• First, the uptrend support trend line was broken. On any rally, I am open to a retouch and failure. A close back above the trendline would be significant.
• Second, the 5733 December futures low was only barely above the key 5725 support (see rectangle). Note the blue triangle momentum buy signal generated shortly after this week’s low. The S&P 500 low was 5702 during Thursday’s afternoon session but held above key 5674 SPX support.
• Third, I have listed three other potential targets that could be hit and then a subsequent reversal would form a bullish failed breakdown. I will track those levels early this week and especially on Tuesday night after the exit polls/election predictions and Wednesday’s (hopeful) resolution.

The sentiment backdrop is fragile: The Conference Board listed that 51.4% of consumers expect stock prices to increase over the year ahead, the highest reading since they first asked that question 37 years ago. That type of optimism never ends well, although it does not have to end now.

Fodder for Bears: NYSE Composite update—Broken box

Last week I wrote “To confirm a break of the 5674 S&P 500 cash level, I am looking at the three-week consolidation” in the NYSE Composite Index. I warned a break of that consolidation’s 19,300 low “would mean buyers no longer accept 19,300 as value, a meaningful regime change. A break of this level carries even more weight than the break of the more widely watched S&P 500 Index’s 5674 support.” The key level did not hold, as seen below.

The breakdown gives greater importance to this NYSE weekly chart, which shows that the major upside target that was projected back in Q2 2020 was hit and rejected at the 2.0 price extension. The NYSE trend model has been negative for the second consecutive week (see red bar).

The pattern is negative and remains so until a daily and weekly close back above 19,300.

Fodder for the Bulls

First, an important divergence occurred; despite the NYSE Composite failure, the S&P 500 did not break its key level. Additionally, the NASDAQ Composite bounced off a confluence of support at 18,080 as seen below:

That support also fits with the QQQ weekly chart that sold off last week after the prior “candle that occurs at highs” but it too held at a critical support level at 486:

The 486 level and last week’s 483.75 low are key levels this week for exposure management. Bullish tone depends on them holding through mid-week, and the same is true with 18,080 in the NASDAQ Composite.

RSP Update: Unadulterated, no airbrush

We are back to where I drew the 176 key support level in RSP, the equal-weighted S&P 500 ETF. The chart annotations are from over one month ago. Perfect place for a rebound to new highs at 183.60 and a perfect place for a breakdown.

Textbook pivotal setup around 176, another number to watch this week.

Fixed Income: The two-year yield is the crucible?

Weekly Trend: Bearish

Weekly trend model continues bearish:

10-year Treasury yields closed just under 4.325% Ichimoku cloud resistance.

There is the cloud and a downward trendline off the highs that will bring in more selling on a breakout.

2-year yield: showing strains?

I will be focused on the 4.09% support level in the 2-year Treasury note during Thursday’s FOMC press conference. That resistance is now support, as seen by the breakout and reversal to a bullish yield / bearish note trend (blue bar).

In case Powell hints about the possibility of a pause at the December meeting when he speaks to the press on Thursday, the 2-year yield should rise.

If there is a lack of visibility about a winner at the time of the press conference, and rates are not lower on a flight to safety, then that means there is a risk premium problem weighing on the market. Let’s revisit later this week but be watchful.

Crude Oil: Support looms large

Weekly Trend: Bearish

Concerns about an Israeli invasion dominated the bearish news out of the U.S. Energy Information Administration (EIA). The EIA reported that August’s domestic crude output rose 1.5%, hitting a record 13.4 million barrels per day. Tighter inventories reported this week by the EIA also helped support prices, as did Saudi’s Energy Minister confirming Tuesday that they will not increase production levels beyond their current capacity of 12.3 million barrels per day.

Consistent with Saudi’s announcement, OPEC+ agreed today to delay a December oil output increase. Finally, Hezbollah’s attack this weekend will probably increase concerns about an Iranian attack through Iraq.

The $65 support region in WTI crude futures held and produced a bounce in the second half of the week on war concerns. The monthly crude futures chart shows that the lower Bollinger Band support has been a good buying location (see arrows in the chart below). There have been only two instances over the last 20 years of a break of that support, in 2014 and 2020 (see circled areas)..

The close this week at $69.50 underlines the importance of my comment last week that “$69.50 continues to be an important level, except now it is support.” ?

After the election, respect any break below $65 support as being quite negative, but the risk return is bullish above $69.50 from a trading perspective.

Best,

Peter Corey

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