Moonwalking

"I took an online class at the University of Phoenix on negotiating. I need a priest and a bullhorn…I say you can do it—I mean I don’t want you to jump, I am saying you have the capability…Oh look, he’s flying!.”

—The Other Guys

If the Fed is successful in walking perceptions backwards, do the markets stumble?

Key takeaway: Does the Federal Reserve have what it takes to talk the market out of their view expecting six rate cuts to the Fed’s view of three? From the central bank’s perspective, the only way the market gets what it expects in terms of rate cuts is to get what no one wants: a recession. However, are stocks at new highs and six rate cuts joined at the hip? Will investors keep stock prices elevated if they must increase their rate forecasts by 75 basis points?

Facing Forward, Walking Backward Dept: My two favorites on the Fed, NY Fed President Williams and Governor Christopher Waller gave back-to-back speeches that spoke to the need of walking the markets back. Williams spoke on January 10, and Waller on January 16, setting the groundwork for the January 30-31 Federal Open Market Committee (FOMC) meeting. They both mentioned that restrictive monetary policy has done the job of dampening demand and contributing to lower inflation.

Williams discussed that the Fed has upheld its first mandate of maximizing employment, and prices have come down with only a slight increase in unemployment 3.7%, which is in line with his long-term unemployment forecast of 3.75%. Waller mentioned that thanks to strong labor demand, high job vacancies acted as a cushion and prevented unemployment from rising to the point of causing a recession. Normally a sharp rise in unemployment is the result when the Fed raises rates sharply. He pointed out that restrictive monetary policy reduced the job vacancy rate (from 7.5% to 5.3%) but not employment.

The key phrase that both Williams and Waller use is that restrictive policy is helping achieve a balance between supply and demand and restore price stability. Not helped achieve, which would have conveyed they are ready to reverse policy by cutting six to seven times, but helping achieve, meaning the restrictive process must continue.

Williams forecasts a 1.25% GDP rate with 4% unemployment and PCE falling to 2?% for yearend, hitting the 2% target in 2025. As he looks ahead, policy stays restrictive for some time, and concludes with “our work is not done.”

Both FOMC voters see two-sided risks:

• supply imbalances could arise fueling inflation,
• inflation could stay sticky, but
• they do not want overly restrictive policy to weaken the economy too much.

Waller spelled it out even more clearly: “As long as inflation doesn’t rebound and stay elevated, I believe the FOMC will be able to lower the target range for the federal funds rate…to…three 25-basis point cuts in 2024.”

However, Waller emphasized that his “concerns about the sustainability of these data trends requires changes in the path of policy…can and should be lowered methodically and carefully.”

While the market is expecting a typical, and dramatic rate cutting move, the consensus is wrong to assume the Fed will act as it has during previous cycles:

Typically, a recession occurs after the Fed tightens, forcing the FOMC to cut fast. Waller is looking at the current environment “with economic activity and labor markets in good shape and inflation coming down gradually to 2%, I see no reason to move as quickly or cut as rapidly as in the past.”(my emphasis).

The FOMC’s and the Market’s Conundrum

The lines are drawn: the market forecast of six cuts in 2024 will not occur if the Fed engineers a soft landing. Perhaps this reveals a core problem—do investors believe that the soft-landing scenario that drove stocks to all-time highs can only be engineered with a 150-basis point reduction in the funds rate? That is, if investors must walk back their interest rate expectations to get in line with the Fed’s view of a 4? - 4?% Fed Funds yearend target, do they maintain their earnings forecasts, or do they move lower and stock prices need to fall?

Perhaps the market threads a needle, considering we have hit new highs as rate expectations have moved from seven hikes to six, starting at the April/May meeting and not March. Yet, the hurdle remains that the expectation is still for six cuts in six meetings, whereas the FOMC is looking at three cuts in the last three meetings, September, November and December.

When an About Face Turns into Losing Face:

• Speaker Johnson only getting 107 Republican votes for the continuing budget resolution with 106 voting against the budget deal. The fact that there is no clear policy direction within the G.O.P. and a split on a major issue such as the budget during an election year is a risk.
• The U.S. only getting England involved in a hoped-for western allegiance to attack Houthi targets in Yemen. Furthermore, England is hesitant to continue. That speaks to the current state of western countries’ hesitance to back up the U.S. and also may contribute to a Saudi Arabian entrance into the BRICs economic alliance.
• ESG funds saw a $5 billion withdrawal last quarter, the 6th outflow in the last 7 quarters, after 5 quarters of large $10-20 bln inflows starting in 2021. Politics and insufficient regulation are obstacles to the hope for the U.S. sustainable funds industry eclipsing Europe.
• China is stumbling through their own version of a Texas Two Step: against a backdrop of slowing credit and PPI, the government lurches between bailing out ailing industries and then clamping down on them. Additionally, China’s largest and state-owned broker, Citic Securities, banned short sales for certain margined clients last week, similar to a move that was rolled out last October. This action occurred two days after Chinese Premier Li laid out a bullish macro view on China and reassured a Davos crowd on their commitment to being pro-business and opening their economy.

Taiwan Revisit

A quick note on how our domestic politics can color our international policies. Since anti-China rhetoric resonates with the electorate, we may see Washington on both sides of the aisle escalate the Taiwan-Chinese conflict. However, party conflicts have prevented hundreds of military appointments and kept spending bills stuck in defense committees, which has diminished our ability to “carry a big stick.” The fact is that China is far more tolerant of a U.S. military presence in the region than if we were to move away decisively from the one-China policy; that is why the House introducing a motion to formally recognize Taiwan is problematic. In China’s eyes, Taiwan cannot continue as a separate country, because it is proof that Chinese society can flourish in a democracy. A smooth path where the U.S. navigates between creating a democratic space for Taiwan while not antagonizing China is going to require a deft hand and delicate diplomacy. I fear that delicate is not going to describe our political environment in 2024.

Markets:

Equity Market: Divergences abound—does it matter?

Weekly Trend: Bullish

In line with the theme of moonwalking, despite the new highs in NASDAQ, S&P 500, and the Dow, the NYSE Composite and Russell Indices did not make new highs (nor did the equal-weight S&P index). Here are two charts of interest.

The S&P 500 is showing a divergence with its advance/decline line shown in red, which can occur at tops:

This divergence is also seen across every major index on Friday’s close, even the NASDAQ Composite. Only the Nasdaq 100 and the Dow saw a new high in the advance/decline line.

Another illustration of the lack of broad participation is seen in the number of stocks trading above their 20-day moving average:

Normally all-time highs are seen as sustainable if there is broad participation. That is certainly not the case, although it does not mean that the rally in the indices cannot continue with only a few tech stocks driving it, nor does it mean that lagging stocks cannot begin to move higher from this point onward.

The drop in the chart above was quite dramatic from the beginning of the year, and almost reached the 20% level where the indices normally bottom out, not hit new highs. It is for that reason that I want to focus on the daily chart of Apple, which rallied strongly throughout 2023 after its low near 125 last January, falling just shy of 200 on December 2023.

It is because it rallied so strongly late into the year that Apple, along with the other mega cap tech stocks, got sold so heavily in January for tax reasons. That may be the sole reason it did not make a new high on Friday, but there may be more to it than that.

Normally I shy away from technical analysis on individual stocks. However, there are so many price targets this chart hit exactly that I have followed it closely. It fits with the moonwalking theme of shuffling backwards, at least up until now.

The daily chart below shows that the price advance in 2023 can be counted as 5 waves up into the high. Importantly, the drop since then can be counted as the start of an impulsive selloff with 5 waves down and 3 waves up on a smaller scale (see the red labels marked 1 and 2 at the right in the chart).

Apple’s rally since Wednesday has it sitting under two key levels. It has yet to move above 192.50, where it ended the year. It also coincides with a .618 retrace level, a common point for a correction to reverse. Assuming Apple breaks above that level, for two days this week, then the topping scenario is probably wrong, and my targets lie 5-10% higher in the 202-211 zone and would confirm a rally that would move above 4900 in the S&P 500.

As for levels to watch in the S&P 500, the breakout above the channel I had listed last week creates a higher sell point than the 4690 S&P 500 trigger point where I become defensive. I add a new concern on a break below 4800. After a strong breakout, old resistance becomes support that should not be broken. If Apple cannot close above 192.50 next week and the S&P 500 begins to break below 4800, that is a clean negative signal. Otherwise, stick with the positive weekly trend.

Fixed Income: QT interference?

Weekly Trend: Bond Bullish/Neutral

Assuming the Fed begins to slow its monthly balance sheet reduction, the Fed’s balance sheet may not get to its original target of $5 trillion, which does mean that less restrictive overall monetary policy is better for growth and negative bonds. That downward pressure could add to the potential negative sentiment if there is a shift back to auctioning more bonds (remember that the Quarterly Financing Announcement is scheduled for the same day as the FOMC meeting, on January 31). ?

The 10-year yield did close a few basis points above the 4.09% resistance level discussed last week. That was the reversal point to consider going short fixed income. However, the trend model has not reversed, still closing on a red bar, making for an ambiguous signal.

A daily chart of TLT, the bond ETF, has moved below an important support. It will take a move back above 96.50 resistance to confirm that the yield model above is correct, and the bullish trend is intact

Crude Oil: Seeing signs?

Weekly Trend: Neutral/Bullish

The IEA increased its 2024 demand forecast by 180,000 to 1.24 million Bopd of y/y growth due to Chinese growth and lower prices, but is also expecting a 100,000 supply increase in non-OPEC countries to 1.3 mm Bopd y/y growth. So, supply overhang remains a major issue. That is why the market rallied on lower U.S. inventory data helped by the Houthi’s declaring that they are now in direct conflict with the U.S.. Note in the weekly chart below that the trend model reversed to positive (blue bar):

Crude sold off once again into the weekend, so there is no major follow through despite closing the week on a blue bar, the first strong signal that futures can reach the first level of resistance at $78 for WTI crude. The top of the Bollinger band shown above is at $94, a reasonable intermediate target once the rally strengthens to the point where it can clear $78.

Best,

Peter Corey

Pave Pro Team

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