Overthrow

“You want to do this now?”

—Dead Calm

Will Political Regime Change cascade into the markets?

Key takeaway: Price momentum is still dominating equity markets. It is becoming increasingly clear that the weakening Household Survey in the payrolls report is a legitimate tie-in to the tech bubble. See Markets section for the importance of 20,433 in the Nasdaq 100 cash index. Life is not measured by a ruler, and neither are markets, but that number is all you need. Clean parameters from the bond market about when supply concerns materialize.

Quick note on the French elections: While the far-right failed in its overthrow attempt of the supra-nationalist Macron agenda, the left will try to overthrow the pro-business Macron agenda. France is left with three parties, each with significant national support, very little common ground, and little interest in compromise.

The RN party still won the largest portion of seats with at least 120 and refused to join any coalition. Unfortunately, the NFP alliance of far-left Jean-Luc Melenchon and Olivier Faure’s socialists will not join any deal with Macron. Melenchon intends to implement the full socialist program, with Faure wishing to overturn Macron’s pension reform. The left is viewing the results as a mandate to spend, while Macron is saying it is simply a no vote for the far right. From what I wrote last week: “Certainly, if the NFP fares even better than expected, the anxiety over excess spending will be magnified.” The market will need to come to terms with NFP plans to blow out the deficit even further above the 3% of GDP trigger.

Markets Imitate Life Dept: The S&P 500 price pattern shows a textbook ending pattern where a narrowing range then breaks out above its upper trendline, called a throw over. The throw over potentially signals the end of price distribution, signaling a top and a strong selloff to follow. Note in the chart below, I have also circled the action going into the March 2020 top. While I do not expect any reversal matching the violence of the 2020 selloff, the topping pattern back then, including the oscillator divergence, is similar to what we are experiencing now.

With this type of setup, I would normally have no problem declaring this a great time to short.

However, the Pave asset scoring engine, powered a strategy that outperformed the S&P 500 by an average of over 3% a year for over a decade (trading billions, not a simulation) continues to report that the market is rewarding stocks with positive momentum. This is not just in the U.S.: we calculate these scores weekly over 9,000 global securities. When momentum is still being rewarded by the Pave equity scoring models, I prefer to wait for a reversal.

A market topping process will be confirmed with a high-volume selloff that breaks below 5445 at a minimum in the S&P 500. Then below 5400 (the black support line shown above and the top of the CPI gap), and finally on a close through the low of the gap at 5375.

Overthrow Number Two

The Household survey peaked in November 2023 and has fallen by 667,000 as of the June payroll report, while the payroll survey has increased by 1,669,000(!). The chart below shows that the payroll survey has increased its gap above the household survey—even after adjusting for the different survey methods to put them on even ground—from 1,555,000 in November 2023 to 3,917,000, an increase of 2,336,000 jobs.

I highlighted the current episode to illustrate just how far the payroll survey has overshot the?household survey. A similar attempt to overthrow the lagging results of the household survey occurred during the rollout of the Internet into the tech bubble.

An Oldie but Goodie

The lesson from the above chart into 1999/2000 is that things can continue longer than you can remain solvent. However, echoing our earlier comments on respecting momentum, the chart below is raising a flag. This is one of my favorite employment charts, and it measures those who have lost their job not on temporary layoff.

The yellow highlights show that before recessions, this series begins to rise. The red lines represent the current level of job losers relative to where the series stood before the recessions of 1991, 2001 and 2008. This chart is akin to the rising continuing claims chart featured a few weeks ago, which shows those who have lost their jobs are having a challenging time finding a new one.

We are stepping on thin ice, because it is going to become clear soon that a small decline in job openings and a slight increase in layoffs will have a much higher impact on the unemployment picture.

The message is that there is a threshold above which the economy struggles to grow, and we are either there, or quickly approaching that level where recessionary forces will overthrow the growth regime.

Overthrow Number Three

I mentioned that momentum is a characteristic that is still being rewarded by the market. But the Pave scoring models are also observing investors beginning to value companies that can cover their interest expense and penalize companies that cannot. That can mean one of two things: either interest expense is going higher, profits are going lower, or both. The conclusion is that our models are picking up that capital is flowing toward firms that can weather a downturn in the business cycle.

This is more of a shot across the bow than an overthrow. Specifically, the interest coverage ratio (earnings before interest and taxes divided by interest expense) and the current ratio (current assets over liabilities) are scoring high. The interest coverage ratio shows if a company can service its debt out of earnings, and the current ratio measures a firm’s ability to pay its immediate debt obligations with cash and near-cash assets on hand.

Momentum remains a major factor, so we can still believe in a “if it ain’t broke don’t fix it” world where market trends are in place. However, this new dynamic in our scoring ranks warns that things may be closer to being broken than investors focusing on a calm surface may expect.

Markets:

Equity Market: Believe what you see

Weekly Trend: Bullish

Quick note—last week I had written that a break of 5510 in futures will trap a lot of longs but “it is critical to be mindful of a failed breakdown” and the latter is what played out. Tuesday premarket we broke down to 5503, and then quickly reversed. I had expected a break of 5510 last week to be “the first signal the topping process has begun” and that did not occur. As the Pave models have laid out, the upward trend momentum reasserted itself. Finally, last week I mentioned I could not rule out an extension to 5560 in the cash S&P index, but it was not my base case. We hit that level, and I was wrong not to give the throw over scenario more weight.

Fibonacci Clasico

Only one chart to focus on in this section as far as I am concerned (aside from the SPX overthrow at the top of this commentary): the NDX weekly displaying a perfect ABC ending pattern. Note the initial rally in black (“A” below in black) of 10,000 points (OK,9992) that was then retraced by a near-perfect .618 selloff into the October 2022 low (“B” below in red). The rally into Friday fell 40 points, or about 20 basis points, short of an exact 9992 points to match the rally off the March 2020 low (“C” in green):

The exact level that matches the 20-month rally that began in March 2020 and ended in November 2021 is 20,433, versus Friday’s 20,392 close. Interestingly, the current rally is also 20-months in duration.

Therefore use 20,433 in the Nasdaq 100 as the key pivot for position management

Markets are messy and market tops tend to be even messier, so perfect relationships and ratios can be dangerous to rely on, but I also have learned that one of the most important lessons in trading is Believe what you see.

Fixed Income: 2s10s in search of a positive term premium

Weekly Trend: Neutral

With the approach of the Quarterly Refunding Announcement at the end of July I am expecting some movement to price in a positive term premium. The 2-year 10-year yield curve is still decidedly negative, but it has bounced off support:

The resistance region at -20 basis points has been in existence since the equity rally began in 2022. It would take a move above -20 basis points in 2s 10s yield spread to get the conversation going that the fixed income market is finally becoming concerned about supply.

The next chart of weekly 10-year note yields shows that the market has been trapped in a 4.20%-4.48% range.

We will be watching that 28 basis point range in yields as Yellen speaks on Tuesday at 10:00, the same time that Chairman Powell presents his semi-annual testimony to the Senate Banking Committee. We would suggest also looking at June’s Employment Trends Index out Monday at 10:00. The May number showed a slight uptick from its 2-year downtrend.

Treasury supply concern becomes real on these twin drivers: a move above 4.50% in 10-year yields, and a breakout above -20 basis points in the yield curve.

Crude Oil: Fatigue?

Weekly Trend: Bullish

The weekly chart made a higher high and higher low, but the daily chart shows hesitancy to drive prices much higher after an enormous 16.5% rally over the past month.

Note the upper tails on candles that I have circled from last week that are analogous to the price action in April: there is clear selling coming in as WTI futures approach $85. I have drawn a line at $82.50 that could come into play after Wednesday’s monthly OPEC report for July. The June report showed an unchanged supply demand balance from May. We will see if recent geopolitical events in Europe or weaker economic data in the U.S. or the continued China overhang will cause softness in their demand forecasts.

Best,

Peter Corey

Pave Pro Team

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