Last week, we discussed the
weakness of the underlying market as “FOMO” had
returned to the market.
“The only concern we have is the lack of
breadth as of late. As shown, the number of stocks above the 50-dma turned
sharply lower this week. Furthermore, they are well below levels when
markets typically make new highs. The same goes for the number of stocks
trading above their 200-dma’s.”
Chart updated through Friday.
Over the last couple of weeks, the market has been warning to the risk of a
downturn, all that was needed was a catalyst to change sentiment.
That occurred as news of a new “Covid” variant
broke, stocks marked “Black Friday” by
plunging firmly through the 20-dma and support at recent lows. Notably, that
downside break broke the consolidation pattern (blue
box in the chart below) that began in early November. While there is some
minor support around 4550, critical support lies at the 50-dma at 4527. That
support level also corresponds to the September peak.
With mutual fund distributions running through the first two weeks of December,
there is additional downside pressure on stocks near term. However,
our “money flow sell” signal is firmly
intact and confirmed by the MACD signal. Such suggests we continue to maintain
slightly higher levels of cash.
Notably, the market
is getting oversold near-term, with the money-flow signal depressed. Such
suggests that any further weakness will provide a short-term trading
opportunity. As discussed last week, the statistical odds are high that
we will see a “Santa Rally” as most
professional managers will position for year-end reporting.
Just remember, nothing is guaranteed. We can only make educated guesses.
Will The Fed Slow
While “Black Friday” usually marks the
beginning of the retail shopping season, the question is whether the new “variant,” which
is flaring concerns of additional lock-downs, will reverse the current economic
Barron’s notes, it will be worth watching the Fed closely.
“Fixed-income markets are signaling that
the Federal Reserve will have to increase interest rates sooner than
expected, which could put a dent in the stock market.
The yield on the 2-year Treasury note
has gone from 0.5% in early November to 0.64% as of Wednesday. The move
suggests that investors expect the Fed to raise interest rates to
combat inflation that remains higher than expected because of soaring
consumer demand and supply chains that are struggling to match demand.
Indeed, minutes released Wednesday from
the Fed’s meeting earlier this month show that members of the central bank
are prepared to increase rates sooner than previously anticipated if
inflation remains high.”
Of course, this was before “Black Friday” sent
yields plunging 10% lower in a single day. Suddenly, the bond market is starting
to question the sanity of hiking rates in the face of an ongoing pandemic.
While many pundits have suggested higher interest rates won’t matter to stocks,
as we will discuss momentarily, they do matter and often matter a lot.
The surge in the new variant gives the Fed an excuse to hold off tightening
monetary policy even though inflationary pressures continue to mount. But, what
is most important to the Fed is the illusion of “market
What “Black Friday’s” plungeshowed
was that despite the Fed’s best efforts, “instability” is
the most significant risk to the market and you.
More on this in a moment.
Time To Buy Oil?
Once a quarter, I review the Commitment
Of Traders report to see where speculators place their bets on
bonds, the dollar, volatility, the Euro, and oil. In October’s update, I looked
at oil prices that were then pushing higher as speculators were sharply
increasing their net-long positioning on crude oil.
We suggested then that “the
current extreme overbought, extended, and deviated positioning in crude will
likely lead to a rather sharp correction. (The
boxes denote previous periods of exceptional deviations from long-term trends.)
The dollar rally was the most crucial key to a view of potentially weaker oil
prices. Given that commodities are globally priced in U.S. dollars, the
strengthening of the dollar would reduce oil demand. To wit:
one thing that always trips the market is what no one is paying attention
to. For me, that risk lies with the US Dollar. As
noted previously, everyone expects the dollar to continue to decline, and
the falling dollar has been the tailwind for the emerging market, commodity,
and equity ‘risk-on trade.” – June 2021
Since then, as expected, the dollar rally is beginning to weigh on commodity
prices, and oil in particular.
While the dollar could certainly rally further heading into year-end, oil prices
are becoming much more attractive from a trading perspective. The recent
correction did violate the 50-dma, which will act as short-term resistance.
However, prices are beginning to reach more attractive oversold levels.
There are also reasons to believe higher oil prices are coming.
Higher Oil Prices
The Biden administration released oil from the “Strategic
Petroleum Reserve,” attempting to lower oil prices. He also tasked the DOJ
to “investigate oil companies for potential price gouging.” These actions are
thinly veiled attempts to regain favor with voters but will not lower oil
Oil prices are NOT
SET by producers. Instead, speculators and hedgers set oil priceson
the NYMEX. Think about it this way:
companies are setting prices to “reap profits,” why did oil prices go below
ZERO in 2020?
would producers need to “hedge” current production against future delivery?
There are two drivers reflecting positioning by speculators and hedgers:
isn’t rocket science. Look at the sharply lagging rig response to the rise
in energy prices post the Covid crash. This is an anomaly.
According to history, there should
be ~1,300 rigs in operation today based on current oil prices. With
only ~480 rigs running today, oil’s prospects may be bright over the long
With output at such low levels, OPEC+ refusing to increase production, and
“inefficient clean energy” increasing
demand on “dirty energy,” higher future
prices are likely.
If the economy falls into a tailspin, oil prices will fall along with demand, so
nothing is assured. However, the ongoing decline in CapEx in the industry
suggests production will continue to contract, leaving it well short of future
That is the perfect environment for higher prices.
Rates Will Lead To Market Volatility
Did “Black Friday’s” plunge send a
warning about rates? Last week, we discussed that it isn’t a question of if, but
only one of when.
I showed the correlation between interest
rates and the markets. With the sharp drop in rates, it is
worth reminding you of the analysis. It
is all about “instability.”
The chart below is the
monthly “real,” inflation-adjusted return of the S&P 500 index compared to
interest rates. The data is from Dr. Robert Shiller, and I noted
corresponding peaks and troughs in prices and rates.
To try and understand the relationship
between stock and bond returns over time, I took the data from the chart and
broke it down into 46 periods over the last 121-years. What jumps is the
high degree of non-correlation between 1900 and 2000. As
one would expect, in most instances, if rates fell, stock prices rose.
However, the opposite also was true.
Notably, since 2000, rates and stocks rose and fell together. So bonds remain a “haven” against
As such, In the short term, the markets (due
to the current momentum) can DEFYthe
laws of financial gravity as interest rates rise. However,
as interest rates increase, they act as a “brake” on
economic activity. Such is because higher rates NEGATIVELY impact a
highly levered economy:
Higher borrowing costs lead to lower
The massive derivatives and credit
markets get negatively impacted.
Variable rate interest payments on
credit cards and home equity lines of credit increase, reducing consumption.
Rising defaults on debt service will
negatively impact banks which are still not as well capitalized as most
Many corporate share buyback plans and
dividend payments are done through the use of cheap debt.
Corporate capital expenditures are
dependent on low borrowing costs.
The deficit/GDP ratio will soar as
borrowing costs rise sharply.
Critically, for investors, one of the main drivers of assets prices over the
last few years was the rationalization that “low
rates justified high valuations.”
rates are bullish, or high rates are bullish. Unfortunately, they can’t be both.
What “Black Friday’s” plunge showed was
the correlation between rates and equity prices remains. Such is due to market
participants’ “risk-on” psychology.
However, that correlation cuts both ways. When something changes investor
sentiment, the “risk-off” trade (bonds) is
where money flows.
The correlation between interest rates and equities suggests that bonds will
remain a haven against risk if something breaks given exceptionally
high market valuations. The market’s plunge on “Black
Friday” was likely a “shot across the
It might just be worth evaluating your bond allocation heading into 2022.
The views expressed by Lance Roberts are not
necessarily those of RetireEarlyLifestyle.com