S&P500 blow-off top or has it just lost its froth?
The trend is your friend until the bend in the end, and buy the dip, are two phrases often banded about. Knowing whether the top has been printed and a more deep and substantial correction is upon us usually requires working out what the underlying macroeconomics is saying. Which is hard to find out. In a world that is so interconnected and reliant on so many things just working.
Weekly Index Analysis
Technically the S&P500 is in a massive bull trend. Since April 2020 the index has risen from 2571 to the recent all-time high of 4718, which is a whopping 83.5% in 18 months. Since 1926 the average yearly return is around 10%. The stock markets are a function of growth, advances in technology, and humans doing better generally. Only the best companies survive in the indices, so the overall trend is for indices to go higher. Stonks only go up! Lots of firms will not be short of the S&P500 because of this. They do, however, buy the dips.
After 5 straight-up weeks, the S&P500 is frothy and due to a decent pullback with the 20-period moving average and the 4405 level a decent initial target to the downside for those trying to catch the top. The weekly momentum as seen through the 20, 50, and 200-period EMA’s is clearly to the upside and price usually follows momentum. As the saying goes, “the trend is your friend until the bend at the end.”
Sentiment
When the world's richest man can afford to lose $50 billion on a Twitter poll, that's a sign that an asset is getting frothy. Tesla had just surpassed a trillion-dollar market cap and was a bigger company than the top 5, maybe ten energy companies in the United States. Following this tweet, the share price dropped 38%, which is a good level for most investors looking to buy dips.
However, if the overall index that the stock is trading in is to come down some more % points itself, it will be hard for Tesla's share prices to stick at these levels. Value investors will be wanting a good 50% reduction from the most significant swing low to the all-time high.
Other problems facing the Nasdaq and S&P500 are the current moves in the US Treasury markets. Yesterday’s 10-year and today's 30-year auctions were disappointing. The knee-jerk reaction to today’s auction dropped Treasuries, lifted yields, and boosted the US dollar. The S&P500 on this auction alone dropped 10 points instantly and has since dropped a further 10 points at the time of writing. Usually, when there is a move out of the safe-haven of the Bonds, money goes into the higher-yielding risk assets, like the equities markets. The fear for risk assets is that the move out of Treasuries is a signal that the market is pricing in a rate hike from the Fed to combat inflation after the CPI today hit 6%.
Underlying Macro
In the previous fiscal year of 2020/2021, the US government spent $7.744 trillion on the economy. The largest amount of spending ever has been getting larger and larger each year for many years now. At the end of September 2021, the monthly Federal statement shows that $576.830 billion was spent on the economy from the US government. Compared to the near $1 trillion spent in March 2021, this seems a massive reduction, but as it turns out it is $100 billion more on average than pre-pandemic levels. By the end of October 2021 fiscal flows came in at $517.953 billion and year-over-year that was nearly $32 billion more, showing that flows are rising and remaining high. We could be on for an $8 trillion-plus budget spending in 2021/2022, carried on by President Biden's ‘Build Back Better’ plans.
Current daily average flows in November 2021 are around $29.14 billion a day, which is $10 billion a day more on average than this time in September and $4 billion more than this time in October. In 2020 November average flows were $21.93 billion by this date.
The point I am trying to make is that there is more money flowing into the non-government from the US government year on year. This is what I believe helps support the equities and none of this is Quantitative Easing. This is spending on Social Security, Medicare, Medicaid, Defence, and all things the Federal Government is responsible for.
The Federal Reserve oversees keeping prices stable and maximizing employment. Today was a typical Fed day, as we had both inflation data and jobs data.
US Initial Jobless Claims 267k vs Exp 265k. previous week revised higher to 271k and US CPI MM Oct 0.9% v’s Exp 0.6%. Previous 0.4%
Interestingly in the last FOMC press conference Fed Chair Powell mentioned that the FOMC views the rate of earnings increases as an indicator of whether inflation is moving out of the durable goods into the wider economy and today US Real weekly earnings MoM for October were down -0.9%, previous 0.8%. Currently, wages are not accelerating past CPI inflation.
Treasury Secretary Yellen suggested on Monday that the Fed would not allow a repeat of the 1970s which some took as a sign we should have been expecting an inflation rise and that there would be a knee-jerk reaction with Hawkish pricing of the FOMC rate trajectory. This goes some way to explain the rising yields after this week’s Treasury auctions but it goes against the words of the Fed. After the Bank of England basically re-negotiated their forward guidance when they failed to raise rates a week or so ago, it is probably better to just wait for the Central Bank to tell you that they are doing something, rather than betting they will.
So far for me, the underlying macro is suggesting there is a large amount of support under these markets and that any pullback should be a signal to buy into value.
There is one clear fundamental risk event on the horizon and that is the debt ceiling negotiations. The current workaround ceases on December 3rd, 2021 and the central planners and lawmakers need to raise the debt ceiling once again so that Biden fiscal plans can come to fruition. There is a serious consequence if they don’t raise the debt ceiling and that is in the form of not only a government shutdown but also the possibility of a default on the debt. There is no need not to raise the debt ceiling or suspend it together, it is just political will.
Other signs of positivity are coming from the credit creation and lending levels out of the commercial banks. We are seeing a steady pick up in loans and leases and we could be bottoming out on lending for commercial and industrial loans.
With the rising government spending and the increasing credit from the commercial banks, there is a consensus that US GDP will grow in Q4, which will be a further boost for the US economy as the foreign investment will flow towards strength.
Technicals
The daily chart shows that the price action is currently above the 20, 50, and 200-period moving averages and we have already established that this is in line with the higher time frames. A pullback into the 20 and 50 EMA’s has traditionally been a great signal to start looking for a buy entry setup. 4590 and 4515, therefore, are the downside targets for those looking to buy into value and assuming the macro underlying elements to this market don’t change drastically, I am convinced this will work out again. The MACD is currently positive and a cross-over below the signal line may induce more selling from trend-following CTA’s. 4464 is their current trigger level.
Assuming the CTA’s don’t get net short above the 4464 trigger level, the daily 50 EMA looks like the best place to test a speculative long trade, with a more conservative entry being on a confirmation that the dynamic support level holds. Market structure from the swing high printed at the beginning of September 2021, would be a great confluence with old resistance becoming support. Failing that the balance area which formed when the price went sideways during late September to mid-October would be another zone, I would be keen to see a bounce from.