It's Back...
Inflation Shows It's Ugly Face Again
Last week the Consumer Price Index (CPI) and Producer Price Index (PPI) both surprised to the upside, effectively wiping out the market’s hope for a May Fed Funds Rate cut. Last week there was a 52% probability of a 25 basis point rate cut in May (refer to chart below). Now there is a 64% probability of no rate cut in May.
This served as a drag on the market as the S&P 500 ended down 0.34% for the week, while the Nasdaq 100 fell 1.48% for the week. This weakens the narrative that inflation is handled and the Fed can begin its rate-cutting program, which is good for the stock market. It also supports the idea that the market was overly optimistic regarding upcoming rate cuts in 2024, which powered stocks upwards from the October 2023 low.
Intermarket Analysis: Feeling Itchy
The Intermarket picture is itching for a pullback. The 10-year Treasury Rate (TNX), the US Dollar (DXY), and Oil are all in uptrends above their respective 21 Exponential Moving Averages (blue line). They all have inverse relationships with the stock market, so as they trend higher, there usually is a downward pressure on stocks. Our cycles point to this dynamic continuing as we discussed in last week’s post - here.
Technical Analysis: A Nervous Uptrend
The S&P 500 (SPY) had a pretty volatile week but is still trending above all moving averages and is still in an uptrend. The Stochastic Momentum indicator has not broken below to 40 mark, so there is no sign of a breakdown yet. The Money Flow Indicator is showing negative divergence, however, which often precedes a pullback or sideways consolidation. The McClellan Breadth Oscillator is positive but pulled back a bit by the end of the week. Finally, with Net New Highs, it is hard to be bearish at this point, even though the SPY seems to be running into resistance at the $502 to $503 area.
There is a concern. The market has been held up by the strength of Artificial Intelligence and Large Cap Growth stocks. SMCI, the leader of the pack and top performing Large Cap stock YTD went parabolic on Thursday and then dropped 20% Friday. This could set off a chain reaction of profit-taking in AI and tech stocks, which would probably cause the greater market to fall. Notice in the chart of SMCI below that the Money Flow Index is overbought and that every time the MFI gets to the overbought level, a pullback occurs sooner or later. This time it occurred sooner. If profit-taking spreads to other AI-related stocks, it could undermine the strength of the rally.
Cycles: Perfect Storm Nightmare Scenario
There is a “Perfect Storm Nightmare Scenario” for the market that is possible, albeit unlikely. What if this all occurs at the same time:
Semiconductors (SMH) are hit with profit-taking
10-year Treasury rate (TNX) increases
The US Dollar increases
Oil increases
Volatility (VIX) spikes
Semiconductors have been leading the stock market higher, however, the Cycles Composite (blue), Energy Cycle (pink), and Seasonal Cycle (green) show a down-cycle that could begin any time and last until 3/12.
The TNX is also on an up-cycle until 3/27.
The US Dollar similarly is on an up-cycle until the end of March.
Oil appears to be on the verge of what could be a strong up-cycle.
The VIX cycles look ready to spike higher and have an up-cycle until mid-March.
Finally, the S&P 500 cycles show a possible two-legged pullback.
If semiconductors suffer a sell-off while Interest Rates, the US Dollar, Oil, and Volatility increase, that would be many negative factors attacking the stock market at the same time. This could lead to a significant pullback. On the other hand, it’s possible that the increases in the Intermarket assets are not enough to move the needle. We’ll have to see how this plays out.
Sentiment: In the Land of FOMO and BTFD
Sentiment is still red hot as we are in Extreme Greed. You could say this is still a Fear of Missing Out (FOMO) and Buy the F*&k#!g Dip (BTFD) market.
Smart Money and Dumb Money continue to buy every dip.
Volatility: Better Together
Looking at the chart below you can notice that:
When the VIX goes up, the SPY tends to drop
When the VVIX / VIX goes down, the SPY tends to go down. (VVIX = volatility of the VIX)
When the VIX3M / VIX declines, the SPY declines. (VIX3M = 3-month VIX)
Although the VIX is not on a clear uptrend, the VVIX/VIX and VIX3M/VIX are declining. This is another warning of possible volatility coming into the market.
Rotation: A Flight to Oil
Last week money flowed out of Communication Services and Technology and into Energy. This rotation provides a few warnings. First, Energy is a late-staged sector, which often outperforms before and/or during a stock market downtrend. This may also foretell a spike in the price of Crude Oil, which is often linked to an increase in inflation. If inflation is sticky, the Fed could delay its rate-cutting program, which is not desirable for the stock market or the greater economy.
Conclusion
As the market continues to trend higher, many warning signs are stacking up. Furthermore, many of our cycles are pointing to rough waters ahead. Be sure to protect profits for now. A better, less choppy market is possible in late March through April.
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Disclaimer - All materials, information, and ideas from Cycles Edge are for educational purposes only and should not be considered Financial Advice. This blog may document actions done by the owners/writers of this blog, thus it should be assumed that positions are likely taken. If this is an issue, please discontinue reading. Cycles Edge takes no responsibility for possible losses, as markets can be volatile and unpredictable, leading to constantly changing opinions or forecasts.