Preface: Explaining our market timing models
The latest signals of each model are as follows:
- Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
- Trend Model signal: Bullish (Last changed from “neutral” on 28-Jul-2023)
- Trading model: Neutral (Last changed from “bullish” on 24-Jan-2024)
Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.
Subscribers can access the latest signal in real time here.
A time for caution
An additional technical warning can be found when the new highs in the S&P 500 were accompanied by numerous negative divergences.
As well, none of the different advance-decline lines have confirmed the S&P 500’s new highs. While these kinds of negative breadth divergences can persist for months before the market turns down, this is nevertheless a worrisome sign.
The earnings season wildcard
From a fundamental perspective, the upcoming week could turn out to be pivotal for the direction of the stock market. About one-third of the S&P 500 will report earnings and a crucial test is coming up.
Already, Q4 net margins are expected to be substantially depressed compared to recent history.
The results from Q4 earnings season has been mediocre. EPS beat rates have been subpar and upward earnings estimate revisions have stalled, all against a backdrop of elevated forward P/E valuations, which raises downside risk for stock prices.
The Fed decision wildcard
From a top-down macro perspective, investors will hear the Fed’s interest rate decision on Wednesday. While the Fed is widely expected to hold rates steady at its January meeting, the debate will be the timing of the first rate cut. In the past few weeks, the market has pushed forward the timing of the first rate cut from March to May.
What will Fed Chair Powell say about the trajectory of future interest rate policy? On one hand, inflation has been relatively tame for several months, which puts pressure on the Fed to ease rates.
That’s because as inflation falls and nominal Fed Funds stay steady, real Fed Funds will rise and create an unwelcome tightening of monetary policy.
The Q4 GDP report indicates that the Fed may have finally achieved its fabled soft landing. Quarterly core PCE has been running at an annualized rate of 2.0% for two consecutive quarters and real GDP growth is accelerating. In other words, Team Transitory is winning.
On the other hand, Fed Governor Christopher Waller recently pushed back against the transitory inflation narrative, “If these are temporary supply shocks, when they unwind, the price level should go back to where it was. It’s not. Go to FRED. Pull up CPI. Take the log. Look at that thing. The [price level] is permanently higher. That doesn’t happen with supply shocks. That comes from demand. And this was a permanent increase in demand and permanent increase in debt.”
How the FOMC leans in the transitory inflation debate will have profound implication for the future direction of interest rates. If Waller is correct, it would be prudent to err on the side of caution and keep rates elevated for longer than what the market expects.
The QRA liquidity wildcard
Lastly, investors will also be closely watching the Quarterly Refunding Announcement from the U.S. Treasury due on Monday, January 29, 2024.
Net Treasury issuance will continue to grow in 2024 as the fiscal deficit remains elevated. The last QRA announcement sparked a risk-on rally because Treasury issued more short-term paper than expected, which drained the overnight reverse repo account (ON RRP) and provided liquidity to support stock prices. With the ON RRP account nearly drained at the Fed, the U.S. Treasury may have to extend the duration profile of its issuance, which would create headwinds for the prices of risky assets.
In the short run, liquidity conditions (blue line) have been trending sideways for several weeks, which will create headwinds for further equity price gains.
Intermediate term bullish
Last week the post mentioned a possibility of 5-10 % pullback . Is that still your view?
Thanks
That wouldn’t be an unreasonable assumption, but it’s only a guesstimate.
Are there any historical precedents to support such an assumption or it’s mostly technical analysis! Thanks
Remember SVB? Of course you do.
This shortening of debt duration made me think of the sovereigns holding a couple trillion of US debt. Are they kind of trapped? They can sell those long duration bonds for a capital loss or just keep holding them, just like some mortgage holders are locked into their low rates.
If buyers don’t want long duration bonds, then the Fed sells shorter duration, because maybe enough buyers are not convinced that inflation is transitory.
I am of the opinion that federal deficits will continue, this means more money going into the general economy. It doesn’t matter what name they give it, covid relief, student loan forgiveness, whatever, it’s all the same, a buck is a buck. That money gets spent and percolates through the system and eventually someone collects a bunch and puts it somewhere which gives assets a boost. But there is malinvestment, and debts that will be cancelled and money dies. We are not there yet, but the SPAC stories should be a warning. The zombie companies needing to refi may get to do a final refi before the gate shuts. When the Fed really pivots will not be a good sign, because as Ken posted yesterday, when people don’t want to borrow, lowering rates achieves little.
We aren’t there yet. I keep watching yield spreads because this I believe reflects how lenders feel about the market.
US runs huge trade deficits. That’s money leaving the country. Interest payments to foreigners is also leaving the country. How much is the effect of deficits on domestic economy?
Yes, but the money circulates back. They don’t leave the USD as USD in their country. Say they buy bonds, they get the bonds and the $ come back here. So the almost 1 trillion a year of trade balance deficit comes back here one way or another. It should lower the USD but there are other money flows which can raise the $…like carry trades. Same stories with interest payments, if someone in Belgium gets USD they likely convert it to euros, unless they buy some USD paper.. So the bucks come back home. What matters is the deficit. As it grows, that is more money going into circulation. Look at the deficit which was about 1 trillion around 1981 and now it is up 25 fold, the S&P is up more , but still in the same ballpark. The deficit will keep growing, this puts more money out there, it’s inflationary. That’s the thing with fiat, they can try to paper over malinvestments gone bad. Things like QE, changing rules about mark to market, bailing out banks. It’s avoiding short term pain but meaning the pain down the road will be worse.
Thanks! This is helpful in understanding the money flow.
So, keep selling USD and keep buying US assets, including some gold.
“How much is the effect of deficits on domestic economy”?
Long term debt accumulation is one effect. Eventually this debt must be paid for or we need to inflate our way out of it. Having said that, a lot of such debt can be seen as “good debt” that has powered innovation and growth in the US. Without such “debt” US would not have continued to grow over the decades. So far as we are innovating, such debt should be seen as “good debt”.