Mini Meme
“None of you know Stu like I do. Not you, not you, not you, not you, not nobody knows Stu like I do.”
—Zach Galifianakis as Alan, The Hangover Part II
When you know, you know…except when you don’t.
Key takeaway: The Fed is convinced that inflation is going to 2%, and investors are hanging their hopes on the same, not on EPS growth. The problem is that FOMC voters are far more wary than investors. Portfolio managers have hit their highest equity allocations since January 2021, the last time the S&P reached a major all-time high. The S&P took the high road to retouch channel resistance at new highs last week. Normally high sentiment, excessive positioning, and stretched internals point to limited upside and a potential trap door. However, if NVIDIA surprises to the upside, we could see the entire market imitating last week’s souffle-like action roundtrip in GME. Sticking to my view that the risk-return is not favorable beyond 5350 in the S&P 500. Also, more on China below.
Smartest People in the Room Dept: Central bankers’ bravado continues, with a hitch. ECB Governing Council member Klaas Knot’s “I am increasingly confident inflation will converge to the target” and Powell’s “I am confident we will get there” last Tuesday is what the market wanted to hear over the noise. However, it was not reinforced by Wednesday’s CPI report, despite the market interpreting it that way. Granted, the 3- and 6-month annualized inflation data sagged, which is encouraging to the Federal Open Market Committee (FOMC) voters. However, while the ECB will cut in June, the Fed is cooling its jets. The fact is that the Fed’s confidence in meeting the 2% target is fully dependent on the path of core services, and that data only fell by 0.1% to a 5.3% annual rate. Even Powell acknowledged its stickiness even before CPI was released, stating “non-housing services inflation is the one that may take the longest.”
The hope for lower housing services prices (lower rents) is diminishing too, given the influx of employed immigrants and a renewed uptrend in housing prices.
Moreover, the median CPI only fell 8 basis points on the month to 4.25%, buoyed by a continuation of services pricing power. So-called super core services inflation (excluding shelter inflation) is continuing to rise and came in at an uncomfortable 4.9%. The flaw in the market’s logic is that the Fed really needs to be patient for a few months, but the market has interpreted a slightly better CPI inflation number as a binary event that means the Fed rate cutting campaign is now in motion.
The Fed should function as an agent that dampens market volatility. The challenge is that investors have bought into the Fed Chairman’s unwavering belief that inflation is going to fall and they will cut rates. Even when FOMC voters backpedal, as they are doing now, the markets are wed to a rate-cutting regime. There is plenty of potential downside volatility packed into the current market, and the S&P is at risk of a hyper-speculative melt up and then sharp reversal.
My view is compatible with Richmond Fed President Barkin who said it perfectly: “The inflation story is much longer-term than what happens in the market.”
Michele Bowman said she is still open to rate hikes, which keeps her as the most hawkish of the lot. Regarding the topic of rate hikes, I thought Powell communicated a nuanced but important change in his view when he said last week “I don’t think it’s likely that the next move would be a rate hike. It’s more likely that we would hold the policy rate where it is.” A few weeks prior at the May FOMC press conference, he was consistent in commenting that a hike was unlikely, but he had followed that with his opinion that the next likely move was a rate cut.
His commentary was the first salvo in a commentary repeated by an array of Fed voters. It ?suggests to me that we finally are witnessing a coordinated message from FOMC voters who spoke this week:
My conclusion from last week still holds: “Getting more inflation data plus Fed reflection does not mean we get any closer to a resolution, but this is our lot, unfortunately.”
Sentiment Is Rising, but not for the Economy
Last week we discussed the evidence from the NY Fed’s Survey of Consumer Expectations reporting the highest anxiety level over job losses since the pandemic. The University of Michigan Consumer Sentiment Index also showed a spike in the expected unemployment rate for next year. This theme was evident in the Bank of America’s Fund Manager Survey with global growth forecasts weakening for 2025, the first time that happened since November 2023.
Portfolio managers’ softening economic outlook is at odds with their positioning; their stock allocation rose to the highest level since January 2022. That date should ring a bell, because that was when the S&P 500 Index made its previous record high of 4800 before falling to 3500 ten months later. In January 2022 as now, investors expected the bull to continue extending.
According to B of A, investor optimism is borne from hopes for rate cuts, and they do not expect EPS growth. Therefore, the bulls hope is hanging on a valuation expansion. This is a precarious situation if inflation does not fall as hoped. Meanwhile, a blended measure of an inverted VIX, forward P/E ratio and bullish sentiment just hit the highest level in the 32-year history of the indicator, exceeding the 1999/2000 level.
The Last Hope for Meme Stock Mania
There was some excitement last week in GameStop (GME) stock when The Roaring Kitty made are appearance. GME spiked, bringing back memories of 2021:
The level where GME stopped falling could turn out to be a stick save on Friday after poor earnings news that was also dampened by news of a secondary stock sale. If GME holds and rallies in a contained manner next week through NVIDIA earnings, then we are dealing with a potentially sustainable bullish scenario. For now, I look at the ephemeral meme-stock action as foreshadowing what could occur on any fleeting rally in NVDA this week. Caveat: It is hard to bang the table on a binary event, but that is my favored view.
Quick Word on NFIB
The April Economic Trends Survey from The National Federation of Independent Business is one of their large quarterly samples, and the average interest rate paid by small businesses came out at a new high of 9.3%. It was a reminder that credit conditions are a distressing overhang on these smaller firms who represent a major segment driving employment. The hiring intentions index moved up just one point, staying mired at the low end of the range. It is an excellent leading indicator, and Ian Shepherdson is expecting job growth to drop precipitously over the next few months to zero based off that data.
Is there a Real China Story Developing?
First, there is a growing sense that China’s is turning. Germany’s ZEW business survey came out this week, and economic sentiment beat expectations based on a more optimistic view about an improved consumer across the Eurozone, but also for improved hopes for China demand as an export destination. China has been taking routine monetary policy easing steps such as cutting long-term policy rates and reserve requirements that fell short. They went a bit deeper by dropping rates on housing loans and reduced the required deposit for first-time home buyers. They finally took the necessary step of starting an asset purchase program where local governments will take excess inventory off the market. That last step could be a game changer.
As for their stock market, the level of China short selling interest is high, so the next leg up could be boosted by short covering. Alibaba earnings disappointed Wednesday, but then reversed 20% from the lows to close near the highs of the week on Friday, a hallmark of a heavily shorted market.
Below is a daily chart of the China tech ETF CQQQ versus the QQQ. It has been outperforming US tech shares since bottoming in February 2024. The chart shows a serious underperformance throughout all 2023, with a brief outperformance in July/August of last year and this March, both which reversed quickly. The recent rally in China tech relative to the US is important to gauge the momentum in the China story. We will monitor.
Second, A sustained move below the current level in the China Economic Policy Uncertainty Index (EPU) would be a sign that public unease could be abating. Such a drop would create a more stable investment environment. The risk premium placed on Chinese equities can be seen through the EPU, which tracks mainland Chinese news articles for any mention of uncertainty concerning monetary policy, fiscal policy, or government directives for the economy or business. The index is now down to the top of the range formed from 2000-2016, an extremely stable period in this indicator’s long history. That period basically coincided with China’s economic ascension under Hu Jintao from 2002-2012, and the early years under Xi.
The recent drop has not been matched by the risk premium priced into Chinese equities, which has been at the highs lately. One of these series is wrong.
Additionally, news out of Japan that its quarterly annualized GDP was -2% with a GDP deflator inflation rate of 3.6% could result in capital flows shift out of Japan and into China. Japanese consumption has fallen in each of the last four quarters. Capital flows into China would be accelerated if the Yen happens to appreciate relative to the U.S. Dollar and the Chinese Yuan because Japanese export-oriented stocks would become less attractive. The Q1 GDP report showed exports fell by the largest amount since February 2020, even though the Yen became cheaper by 7% over that period, so it would have been worse if the Yen had risen.
Third, metals may be sending a positive signal to investors. I had mentioned copper in the previous commentary, and it had a big move last week. However, silver had an even bigger meme-like blowoff move. The daily chart below shows that the silver futures had one of its largest daily ranges in years on Friday:
Commodity markets often have their biggest ranges to finish off rallies in a buying climax. This also happened near some important price targets of mine. I am watching the $30 dollar support level. Below $30, silver could reverse, and it may have implications for investor enthusiasm for China. If you engage in China or are thinking about it, check silver’s price action in the coming weeks.
Markets:
Equity Market: Riddle: When is a new top not a top?
Weekly Trend: Bullish
Answer: When it is an expanded flat. The S&P 500 did get the retouch of the channel from below as it reached new highs. That is called an expanded flat pattern, and the B-wave can project as high as 5350 and still be part of a downward correction. There are two ways this can unfold, and both have a negative risk-return in the short term, but in one case, it opens up the possibility for a massive rally to unfold after the correction is done. This formation normally targets 5350 in the S&P 500 index, and if the pattern is correct, can usher in a swift and steep correction.
领英推荐
Last week I wrote: “I am leaning bearish, led by the Russell, unless it begins to trade higher this week. A move higher in IWM from here would suggest a touch of the S&P 500 channel from below, which would constitute new index highs. This is not my base case, but because this is a market to sell weakness, not strength, it is best to let it unfold.”
We did get that retouch on Thursday at a new high.
Notably, NYSE stocks above their 20-day moving average hit 70%, which is quite high, but 80% is a more reliable reversal level. That suggests a rally overhead to 5350 can be realized.
The swing factor is NVIDIA earnings this week. If NVDA strongly exceeds expectations, then there is little doubt the 5350 resistance region will not hold, and stocks will drive above it. The question is whether it will be a short-lived blowoff. Price reaction after the NVIDIA data is released and then after the earnings call will be a major determinant of near-term price action.
There is still a weekly perspective that leans toward a bearish development. Going to my weekly chart from last week and comment: “The tell will be whether the oscillator in the lower portion of the weekly S&P 500 Index chart reverses up (see the three times that are highlighted since the October 2022 low).”
The continuation rally last week was not strong enough to push the oscillator positive. If next week does not see a reversal, then I would not consider the bearish side for positioning until we get a red bar in the chart above.
Footnote Dow 40,000: Life imitates art
Many believed David Elias wrote a science fiction novel when he published “Dow 40,000” in 1999. He was proven right on Friday, albeit 8 years later, but hey, he deserves a shout out.
Tie-Breakers Update
The software ETF no longer looks bearish as it crossed above the 82.50 resistance at the green horizontal dashed line from last week, so until it goes back below, IGV is in a bullish posture.
IWM daily
The Russell 2000 ETF daily chart broke the above 207 resistance level mentioned last week but stalled as the S&P and NASDAQ moved to new all-time highs .IWM closed at 208, it would need to fall back below 207 with a break of 206 as initial confirmation of a failed breakout.
The weekly bar is very compressed, so any drop below last Monday’s204.50 low will be a clean signal to sell the Russell and could lead the other indices lower.
Fixed Income: Dueling timeframes
Weekly Trend: Bullish
The weekly 10-year yield reversal model that gave a sell signal (buy Treasury notes) did see the necessary follow through lower this week. It was another example of a market that voted before a big event (CPI) that typically gives a robust signal.
The daily chart below suggests that with yields bouncing off the lower band, the risk return is for higher rates above 4.31%. That would suggest that the weekly chart above could see a limited yield drop, following the Q4 2021 and Q1 2022 pattern. A move under 4.31% on the daily chart below could develop into a sustained bond rally, which would resemble Q4 2022 and Q4 2023. Any analogy to those last two periods would be extremely bullish for stocks, so the action this week in 10-year yields is significant.
An interesting divergence is potentially forming between corporate bond Option-Adjusted-Spreads last hitting their tights on May 7 and rising since then, in contrast to the May 16 equity highs. We will see if OAS spreads make new lows from here to confirm equity bullishness.
Finally, the BoJ cut their bond buying program, a mirror image of the FOMC reducing QT. The Japanese did so as a reaction to partially cap Yen weakness.
Crude Oil: OPEC’s global demand forecasts unchanged for 2024 and 2025
Weekly Trend: Bearish
API and DOE inventory data were bullish this week showing larger draws than expected. However, crude did not move above $80 resistance. The IEA forecast was negative however, forecasting that if OPEC+ cuts were to last through next year, supply could still rise, and the agency slightly cut its demand forecasts through 2025.
The market’s focus will begin to look toward the June OPEC+ meeting, so any clear direction into that event should be taken seriously.
Best,
Peter Corey
Pave Pro Team
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