Mid-week market update: The S&P 500 is stalling just below its 200 dma after becoming overbought on the 5-day RSI and the percentage of stocks above the 20 dma. What technical pattern is it tracing out? Is it a bull flag (shown by the red lines), or a bear flag (black lines).
Bullishness and bearishness are in the eyes of the beholder.
Bull Case
The short-term bull case is based on market positioning. The “Liberation Day” downdraft was exacerbated by a lot of risk managers who forced trading desks to exit their positions. Flow analysis shows that hedge funds sold in size and their equity exposure is extremely low by historical standards. On the other hand, retail investors went all-in and bought the dip, which could be interpreted as contrarian bearish.
In the short run, hedge funds and volatility control funds will need to normalize their risk positions by buying stocks. The re-risking of these portfolios depends on two things, a retreat in volatility which allows greater risk tolerance in VaR models, and a stable bull trend.
Already, we are seeing the VIX Index begin to normalize by falling below 30, but it hasn’t pulled back to 20 yet. The term structure of the VIX normalized from its inversion. That said, news flow and the market reaction to news flow will drive the evolution of volatility and the perception of volatility.
As an example of what to watch, yesterday’s news that Treasury Secretary Scott Bessent and Trade Representative Jamieson Greer will be meeting a Chinese delegation led by Chinese premier He Lifeng in Geneva this weekend sparked only a weak rally. In reaction, the Hang Seng Index opened up strongly overnight but ended the day up only 0.1%.
As well, investors are seeing the re-emergence of price momentum factor, which is an indirect sign that the fast money crowd is buying.
How these factors progress will be key drivers of trading desk risk appetite in the near term.
Bear case
The bear case depends on the Fed’s interpretation of the inflationary effects of tariffs. The Fed stayed on hold, which was expected, and it is taking a wait-and-see position on the effects of tariffs in the face of a weakening economy. The FOMC statement was changed to highlight the higher risk of stagflation: “The Committee…judges that the risks of higher unemployment and higher
inflation have risen.”
inflation have risen.”
Supply chain warnings have been evident for several weeks. Traffic at west coast ports are expected to fall 35%.
An early sign of the effects of shortages and inflation pressures can be seen in used car prices as tariff rates hit auto production. The Manheim Used Vehicle Value Index, which rose 4.9% from a year ago.
Former Fed economist Claudia Sahm pointed out that the Fed has tools to monitor soft data to see how price increases could translate into persistent inflation so that a “wait-and-see Fed” can be a “ready-to-move Fed”. The Atlanta Fed’s Business Inflation Expectations Survey asked how much of a hypothetical 10% and 25% cost shock businesses would pass through to their prices charged. The response was ll over the place. The distribution of pass-through of price increases was relatively flat from 20% to over 80%.
The Beige Book gave insights on the speed of the pass-through, which appears to be relatively rapid. Sahm added that “a rapid adjustment in the level of prices would mean that the test of
whether tariff-induced inflation is temporary would come relatively
quickly
whether tariff-induced inflation is temporary would come relatively
quickly
Expected passthrough rates were substantial, with half of manufacturers projecting a complete passthrough, mostly without lags. One manufacturer shortened the duration of its price quotes to 30 days in anticipation of the need to adjust prices rapidly (Boston Fed, emphasis added).Several firms said that they recently raised their prices because their costs had increased as a result of tariffs. Many firms said that they were receiving letters from suppliers and sending letters to their customers warning that prices could increase in the near future due to tariffs. Several businesses said that until they had a better idea of how tariffs might impact them, they were minimizing new investments and planning for various cost scenarios. (Richmond Fed.)
Another key question is the evolution of inflation expectations. The University of Michigan inflation expectations survey showed a spike in one-year expectations, but a much more muted increase in long-term expectations.
In the absence of tariffs, the Fed would be cutting today, but much depends on the Fed’s reaction function to the inflation threat. Reading between the lines from Powell’s responses at the press conference, my impression is the Fed will take months to react and the pace of rate cuts will be slower than the market expects.
The bulls and bears now know what to watch in the coming days and weeks. Stay tuned.
What causes inflation? Too much money chasing things or too few things. Tariffs will just raise prices, so in a sense we have less money chasing things. If we spend 100 billion and now it would cost 110 billion do we cough up the extra 10 billion or buy what used to cost 91 billion? There’s only so much that can go on credit cards. But then if only 91% of goods in this scenario are being sold, the agencies providing those goods will feel the pinch of a drop in sales unless of course they boost the price to compensate for the tariffs. The cure for high prices is high prices, people will buy less. It’s as if we are all poorer overnight, now how does this cause long term inflation.
There will be a price bump, but unless there is more fiscal stimulus, why should prices keep going up?
My guess is that the Fed doesn’t want to ease because they think inflation will go up because the deficits keep rising and the gov’t will try to buy it’s way out of things, so why lower rates and get the Arthur Burns award? If things get to the point where everyone is screaming to lower rates, they can do it. Globally they will try to print away the old debts which is inflationary, because paying those debts off, forget about it.
It is redistribution of circulating money. Tariffs, being taxes increase the government levy as prices at point of sale rise (which shows up as inflation). With only “91%” of goods being transacted, as you correctly note, it amounts to lower business activity.
Lower business activity + higher inflation = stagflation.
You are correct, down the line headline inflation will drop at some point in time, as government levy (aka taxes) sap consumption power. It amounts to a one time reset of prices.
Juliette Declearcq is on the record predicting the tariff will equivalent to a deflationary shock: people will simply stop buying a lot of the things they previously purchased, because of sticker shock. The famous American consumer, who used to shop until they dropped, will be no more.
How Malaise Economics work out in the mid-term is difficult to predict. I have a scenario where sufficient folks simply get fed up with Shenanganonomics that they cremate the Repubs in the mid-terms, and then it’s over with more than cosmetic, Biden-style tariffs. American do have a history of rah-rahing for the boss, until he turns out to be a loser, after which he’s fit to be tarred and feathered. That would indicate a profitable 2026 for investors who can keep their powder dry.
And in the short-term, we still have this weird bifurcation where MAGA voters put their money where their mouths are, and this keeps the market up. DJT and Fartcoin for the win. But a long-time bull is not on the back of giddy retail made.