All three major US indexes would open the day in the green or just around breakeven. Prices would stay stagnant through the first two hours of the session before the market began a sell off that would bring them into the negative territory. A brief rally nearly brought them back to breakeven, but prices would decline from there and create new daily lows, ultimately closing in the red.
Asian markets were mixed in this morning’s session after hawkish minutes from the Fed, a few poor reports, and Chinese concerns. Australia’s unemployment rate ticked up to 3.7% compared to 3.5% expected. Japan saw its trade balance slip into a deficit in July compared to a surplus the previous month. Singapore’s exports slumped by -20.2% YoY, and South Korea’s export prices fell by -12.8%.
European markets would close marginally lower as market participants digested the latest UK inflation data, which saw CPI slow to 6.8% YoY, from 7.9% in June, matching expectations. The euro area economy expanded in Q2 by 0.3% after being flatlined in Q1.
The VIX would open yesterday’s session at $16.54, slightly above the close of the previous day. Prices would reach a low of $15.80 as bears tried pushing prices below the $15.78 support level. The VIX bulls (i.e. market bears) proved resilient however and managed to fight them off and bring prices to a high of $16.93 before closing at $16.78.
Inertia edged more in favor of upward momentum once again as prices continue to rise and the VIX bulls gain more steam. Strength moved in favor of the VIX bulls for the second consecutive session after the strong rebound showcased on Tuesday.
We said in yesterday’s report that the VIX bears will likely bring strength back in their favor at some point sooner rather than later, as the VIX bulls have had control for too long and were questioning the sustainability of holding the indicator above the centerline for much longer. However, what we failed to mention is that the rally can continue to persist in the meantime before it happens. We do think that prices given the breakout, will continue to rise, as is usually the case with that respective signal. Eventually what we’ll see is that if the rally in the VIX does continue, prices will likely reach another point of resistance, likely at $18, to which we will then reassess the state of the chart. The divergence signal on the weekly chart is working in the rally’s favor at the current moment in time, but we’re still weary of the Hound of Baskerville signal.
The S&P would open a notch below the previous day's closing price at $4,433, and would reach a high shortly thereafter of $4,449. Prices would decline for most of the session, reaching a low of $4,403 in the final minutes before closing at $4,404.
Inertia would continue to gain more momentum to the downside as prices continue their slide while strength would once again move in favor of the bears for the second consecutive session, as the MACD-H is still hovering near its multi month lows showing the bears complete control over the market at the current moment in time.
The bears have managed to breakout even further below the $4,450 level, and we're likely to see the bulls try and reestablish themselves at that point. Based on the VIX’s current trend, which indicates higher implied volatility moving forward, we're leaning in the direction that this will end up being a true breakout from the bears. We’re likely to see the bulls bring prices back to the new resistance level (i.e. old support of $4,450) and try to reestablish themselves there and bring the markets back to rally mode, but given the grip bears have on the markets, if anything we’ll likely see prices consolidate around there, strength pullback in favor of the bulls as price action slows before the bears take over once again.
We’ve been saying for months now that the markets were likely to slow in August as the rally would likely lose its steam by this point, which is exactly what we’re seeing. Hedge Funds are now starting to hedge against equities (see yesterday’s section III-II) and institutional buy ups have slowed, if not ceased all together. We still have a long way to go before this short-term pullback becomes an established trend, but it’s slowly getting there, our expectation in the coming months is the market will experience an inevitable pullback, the extent of which is too murky to tell now, but we believe it will be deeper than what most market participants think.
1.) MarketWatch: Mortgage rates could hit 8%, economists say, citing a worrying sign not seen since the ‘Great Recession’
2.) MarketWatch: Goldman Sachs veteran is getting worried about stocks: ‘This is no longer a buy the dip market’
3.) MarketWatch: 10-year treasury yield pops above 4.3%, highest since 2008
4.) Bloomberg: Global yields march to 15-year highs even as investors pile in
5.) Bloomberg: Emerging market credit risk jumps as hawkish tilt batters bonds
6.) Bloomberg: China told state banks to escalate Yuan intervention this week
7.) Financial Times: Saudi Arabia cuts holdings of US treasuries to 6-year low
The summary of their July 25-26 meeting, released Wednesday, said “most participants continue to see significant upside risks to inflation, which could require further tightening of monetary policy.” At the same time, there was a camp that expressed concerns over the economic outlook, with some Fed officials more worried about an economic downturn, citing, “even though economic activity had been resilient and the labor market had remained strong, there continued to be downside risks to economic activity and upside risks to the unemployment rate,” meaning they’re concerned over the lagging effects of interest rate hikes in the coming months.
Fed officials believed that the data arriving in coming months would clarify whether the “tentative signs that inflation could be abating” would turn out to be a lasting trend. Several Fed officials commented that “significant disinflationary pressures had yet to become apparent in the prices of core services excluding housing,” and that the inflation fight is far from over, which could require additional tightening. "Participants generally noted a high degree of uncertainty regarding the cumulative effects on the economy of past monetary policy tightening," the minutes said.
There were also concerns over problems with commercial real estate. Specifically, officials cited "risks associated with a potential sharp decline in CRE valuations that could adversely affect some banks and other financial institutions, such as insurance companies, that are heavily exposed to CRE. Several participants noted the susceptibility of some nonbank financial institutions" e.g. money market funds.
The minutes highlight many of our own concerns over the future outlook of the economy. The dual threat of keeping rates higher for longer, resulting in a likely significant economic downturn while still experiencing upside inflationary risk - or - cutting rates too soon, which may cause another inflationary spiral while still likely experiencing a significant economic downturn is one of the more forefront matters of discussion and debate in our own war room. Most indexes of CPI have cooled to a significant degree, but there are some where pressures still persist, e.g. energy mostly due to reductions in supply outpacing the degree of slowing global demand, food which has been disrupted by forces of nature (i.e. natural disasters), with many experts predicting droughts and famines in the coming years, specifically in China, as well as core services which we went in depth with in the latest CPI and PPI reports (people are spending their money less on goods and more on services) and more. We’ve also seen an uptick in the pace of price increases within wholesale inflation (i.e. PPI), which will likely translate onto consumers (i.e. CPI) as businesses raise prices to protect profit margins.
We’ve already discussed the risks for an economic downturn in depth many times, so we won’t bother going into detail with them again today. The point we are trying to make is that the Fed is hawkish for a reason, but they’d rather beat around the bush than panic the masses, which is smart seeing as they have a lot more pull than we do here. We do believe they will ultimately pause rates this month although September is still up in the air. After that, it's anyone's guess. They’re taking a reactionary approach as the data slowly releases, which they said was their approach and the only thing we can do is the same thing. But we still stand by our outlook.
Futures are rather volatile as we head towards the open but remain positive. Bulls will have to really overwhelm the bears today if they have any hope of bucking this current pullback, as the sellers are fully in control right now as market participants remain on edge, including institutions and hedge funds. If the bulls can reestablish themselves, we’ll likely be headed for some consolidation at the nearest resistance level (i.e. $4,450). They will have another opportunity to do so tomorrow if they can’t today, as markets may rebound after the beating they’ve taken this week and given there are no major catalysts or reports on the agenda. Friday’s are usually quieter anyways, so the bulls may catch their breath before reanimating in the following sessions. As always, we hope you found this helpful, learned a thing or two, and have a great day.