Was the break above the long-running downtrend line a “head
fake?” Maybe. However, before we get into the analysis, let’s review where
we left off last week. Such is critically the case as we head into this coming
week’s FOMC meeting and policy announcement.
The upcoming FOMC meeting will likely determine the market’s direction over the
next few weeks. While many market participants are hoping for a “kinder,
gentler Fed,” As noted previously, the recent commentary suggests such may
not be the case.
“The most critical tidbit came from St
Louis Fed president Jim Bullard (a non-voter this year), who spoke to the
WSJ’s Fed Mouthpiece Nick Timiraos. He stated that while US interest rates
have to rise further to ensure that inflationary pressures recede, ‘the
US is now ‘almost’ in the restrictive territory.
That point was echoed by Loretta Mester,
as the Fed wants to ensure inflation will come down on a steady path to the
2% target. ‘I just think we need to keep going, and we’ll discuss how much
to do at the next meeting.’ Mester said that she expects the Fed’s policy
rate to go ‘a bit higher’ than 5% and stay there for some time to slow
As we further noted, our concern remains that while the Fed is suggesting
further tightening, the 3-month average of inflation has already returned to the
Fed’s target rate. Such means the Fed is running a significant risk in
overtightening policy and causing a sharper economic downturn than is currently
priced into asset prices.
The reason for the rehash is this coming week’s FOMC meeting, where the Fed is
widely expected to hike rates by 0.25%, will impact market direction. The
risk to the markets is that while the bulls have been driving asset prices
higher since the beginning of this year, that increase in price works against
the Fed’s agenda. The goal of tighter monetary policy by the Fed is to
tighten monetary conditions to slow economic growth, thereby reducing inflation.
However, higher asset prices boost consumer confidence and loosen monetary
conditions. As noted by Liz Ann Sonders, financial conditions have eased
dramatically since October.
Per a speech Jerome Powell gave in early December:
seek to reduce inflation by slowing the economy through tighter financial
as higher borrowing costs, lower stock prices, and a stronger dollar—which
typically curb demand.”
Given that “easier” financial
conditions risk keeping inflation elevated, it will not be surprising to see
Jerome Powell deliver a starkly hawkish message next week. Such was
what Powell did following previous market rallies in September and December to
push markets lower and tighten financial conditions.
This brings us to this week’s analysis. Was this week’s technical breakout valid
and leading to a further market advance, or was it just another “head
Just Another “Head Fake?”
Over the last few weeks, we repeatedly discussed the consolidation occurring in
the market. The compression of prices between the downtrend line from the
January 2022 peak and the rising lows since October was an important focal point
for investors. Such is shown in the chart below.
As you will note, since January’s market peak, each attempt to break above the
falling downtrend line was a “head fake,” leading
to lower prices. The good news is that, eventually, this cycle will end. At some
point, the market will effectively “price
in” the worst outcomes, and a break above the downtrend line will become
sustainable. Such will confirm the beginning of a new bullish cycle for prices.
The evidence of a clear sustained break above the downtrend is not evident. That
keeps the risk of a “head fake” higher
for now. But, as shown below, several technical improvements to the broad market
are worth watching.
While the flow of economic news and media headlines are filled with stories of
an impending recession, the market has been firming since October, suggesting a
potentially different outcome. As
we noted, the inverse “head-and-shoulder” pattern
already suggests a market bottom has formed. A solid break above the downtrend
line (with a successful retest) would
confirm the completion of that pattern.
Furthermore, the market is not extremely overbought, and shorter-term moving
averages are slopping positively. Notably, the 50-DMA is rapidly closing in on a
cross above the declining 200-DMA. Such is known as the “golden
cross” and historically signifies a more bullish setup for markets moving
While it is possible that some bad news or an overly aggressive Fed could cause
a “head fake” short-term, many of these
bullish signals will complete in the months ahead. While that seems odd given
the negative flow of economic and earnings data near term, historically, market
prices tend to trough 6-9 months before earnings bottom. Such is because the
market anticipates outcomes and was the subject of this week’s post on “Contrarianism.”
contrarian investor, excesses get built when everyone is on the same side of
the trade. Everyone is so bearish the markets could respond in a
manner no one expects. This is why equities have historically bottomed
between 6-to-9 months before the earnings trough.”
There are plenty of
reasons to be very concerned about the market over the next few months. Given
the market leads the economy, we must respect the market’s action today for
potentially what it is telling us about tomorrow.
While this may be a “head fake” currently,
I wouldn’t entirely dismiss the message of improving technicals either.
Stronger Than Expected
On Thursday, the Bureau of Economic Analysis reported the first estimate of the
gross domestic product for Q4 2022. The initial read was stronger than expected
on two fronts. The actual measure of economic growth was 2.9% annualized for
2.6% expected, but the inflation measure was also stronger at 3.5% versus 3.2%.
For the year, the economy grew slightly below 1%. Such does not allow the
economy to slow without slipping into a recession. As Mish
“Money supply is falling off a cliff,
another sign of economic weakness.”
That is a critical point, as the surge in monetary supply kept the economy
afloat last year. However, that“pig
in the python” is now exiting rapidly, exposing the underbelly
of the economy. Such will also exacerbate the slowdown when the lag effect of
monetary policy catches up with consumers.
Soft Landing Scenario
While ignored by the market, that stronger deflator will likely cause heartburn
for the Federal Reserve heading into the FOMC meeting next week. As noted above,
with monetary policy conditions easing sharply, the market rally is working
against the Fed’s attempt to reduce inflation.
Nonetheless, the stronger-than-expected GDP report feeds into the “soft
landing” scenario. As
we discussed on Friday, the definition of a “soft
landing, in economics, is a cyclical slowdown in economic growth that avoids
a recession. A soft landing is the goal of a central bank when it
seeks to raise interest rates just enough to stop an economy from
overheating and experiencing high inflation without causing a severe
downturn.” – Investopedia
The term “soft landing” came to the
forefront of Wall Street jargon during Alan Greenspan’s tenure as Fed Chairman.
He was widely credited with engineering a “soft
landing” in 1994-1995. The media has also pointed to the Federal Reserve
engineering soft landings economically in both 1984 and 2018.
The chart below shows the Fed rate hiking cycle with “soft
landings” notated by orange shading. I have also noted the events that
preceded the “hard landings.”
There is another crucial point regarding the possibility of a “soft
landing.” A recession, or “hard
landing,” followed the last five instances when inflation peaked above 5%.
Those periods were 1948, 1951, 1970, 1974, 1980, 1990, and 2008. Currently,
inflation is well above 5% throughout 2022.
Could this time be different? Absolutely, but there is a lot of history that
Furthermore, the technical definition of a “soft
landing” is “no recession.“The
track record worsens if we include crisis events caused by the Federal Reserve’s
actions. As noted above, there were three periods where the Federal
Reserve hiked rates and achieved a “soft
landing,” economically speaking. However, the reality was that those
periods were not “pain-free” events for
the financial markets. The chart below adds the “crisis
events” that occurred as the Fed hiked rates.
The point is that
the “bull versus bear” argument is not
This is why, at least for now, we are allowing the technical formations to drive
investment decisions in the short term. However, we fully expect the fundamental
realities to emerge by this summer, which is why we remain cautious.
The views expressed by Lance Roberts are not
necessarily those of RetireEarlyLifestyle.com