The Divergence Between Stocks and Bonds Widens

by Michael Kramer

6/18/23

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The upcoming week in the stock market is set to be bustling as Jay Powell is slated to deliver his testimony before both the House and Senate on Wednesday and Thursday. It’s unlikely that Powell will deviate from his statements made just last Wednesday. Still, it’s noteworthy that the equity market remains skeptical when Powell indicates that rates are poised to rise. This may push Powell to emphasize the anticipation of more rate hikes later this year.

This situation poses a considerable risk for equity prices, especially now that we have past June OPEX. Consequently, the hedging flows bolstering stocks are expected to dwindle. This coincides with a period when stocks are overbought on the index level, which is set to challenge the determination of bullish investors as flows begin to change and markets appear stretched.

Over the past few weeks, I’ve been discussing the upcoming narrative that foresees several challenges looming over the market this summer. These hurdles include the likelihood of the Fed continuing to hike rates, dwindling hedging flows, and replenishing the Treasury General Account (TGA), all occurring as stocks reach overbought and overvalued statuses. The S&P 500 has escalated more than my initial projections, but the narrative and associated risk remain consistent. Additionally, it could be argued that there’s a mounting risk of a resurgence in inflation during the year’s second half.

The S&P 500 is trading above its upper Bollinger Band, with the RSI trading above 70. This doesn’t necessarily imply that stocks must decline, but it indicates that a consolidation phase might be warranted. This could manifest in stocks dropping or trading sideways until the overbought levels lessen.

 

The same is the case for the NASDAQ 100.

 

The crux of the matter is what’s driving the market. I speculate that a couple of factors are in play, the most significant being the volatility crush we’ve observed as the VIX dips below 15. Another factor could be the newfound conviction in a soft landing scenario, where the economy manages to dodge a recession, and earnings growth remains relatively unscathed.

Such a scenario is plausible, but thus far, we haven’t observed a substantial or tangible increase in earnings estimates for the next three quarters. Earnings trends have been on a downward trajectory over the past few weeks. It’s possible, however, that the earnings might outperform pessimistic predictions when companies start revealing their results in a few weeks.

 

I’ve always leaned towards the belief that we will likely witness inflation staying stubbornly high, with the US existing in a slow, grinding growth environment. History has taught us that periods of high inflation typically coincide with rising unemployment rates, which often trigger a recession. It seems improbable that this time will diverge from the pattern. Indeed, only when the unemployment rate has escalated in the past has inflation been truly suppressed. Thus, I think that even though headline inflation has dropped, bringing it back to the 2% area the Fed desires without elevating the unemployment rate will be challenging. To achieve that, a recession will likely be necessary.

 

Hence, the recent uptick that the stock market has managed to assemble isn’t likely to hold firm, considering that the entire rally is currently predicated on the hope of averting a recession, which doesn’t seem probable. Additionally, the inflation rate is only subdued due to a significant drop in energy prices in recent months.

However, oil is demonstrating resilience on its chart, and if it can surpass $75, it could potentially rebound back to $83. Moreover, as we transition into the year’s second half, oil will be compared against much lower prices. This means that oil’s dampening effect on inflation will gradually wane.

 

The same scenario applies to gasoline, establishing a base of around $2.32. It appears to be moving upwards, potentially returning to $2.85. Moreover, as we progress into the summer, the base effect of gasoline will start to diminish.

 

Even Wheat has shown signs of breaking out of a downtrend.

 

Therefore, as we progress into the year’s second half, the same factors that have helped suppress inflation are likely to start contributing to inflation again. This represents the most significant risk for the Fed and could be one reason we continue to see higher rates. This is because rates are aware of the negative inflation trends looming, and they know the Fed will have to take further measures to temper prices.

This is likely why the US 2-year yield marked its highest close on Friday since mid-March.

 

More significantly, with China likely to initiate growth stimulation measures again, there’s a reasonable chance that commodity prices might start to ascend. The Bloomberg Commodity Price Index appears to be breaking a downtrend, setting the stage for a sharp upward move.

 

This matters to us because the year-over-year change in the value of this index correlates with the ISM Prices Paid Index. If we observe this index climbing, it will add to producer prices, and the recent deflationary trend in goods might start to reverse.

 

My overall perception is that while the equity market is contemplating the possibility of a soft landing, the bond market seems to be considering a scenario of persistently higher rates. This is due to core inflation rates staying resilient and the potential setup for a renewed increase in commodity inflation.

This generally suggests that the Fed will have a significant task at hand to suppress demand enough to lower core inflation. Simultaneously, they’ll face an even bigger problem if China does decide to stimulate its economy and we begin to see commodity inflation kick-start again. This would drive headline inflation higher, which is much harder to combat unless the Fed can somehow cause the dollar to appreciate, which may mean even higher rates.

This scenario likely implies that financial conditions will need to tighten further, and real rates will have to increase. This is typically not beneficial for stocks – it hasn’t been in the past, and it’s unlikely to be so. Therefore, we may be moving towards a period of true stagflation, characterized by rising prices and increasing unemployment, as the Fed strives to suppress core inflation and keep headline inflation from spiraling out of control.

-Mike

Charts used with the permission of Bloomberg Finance L.P. This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.

 

5 STOCK MARKET PREDICTIONS- THE WEEK OF MAY 8, 2023 EDITION

by Michael Kramer

5/7/23

#STOCKS – $GOOGL, $META, $700 HK

#MACRO – $SPX, $NDX

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Last week, the S&P 500 fell by approximately 0.80%, despite surging by nearly 2% on Friday alone. Apple and regional banks saw sharp gains, even with a hotter-than-expected job report. As for Friday’s move higher, it was likely due to the market being oversold to some degree, along with the usual Friday volatility selling and 0DTE crowd being out in full force. However, it’s unlikely that this trend will continue next week. Economic data and Fed speakers will deliver plenty of headlines for investors to consider.

Furthermore, the Fed is now officially past the spoon-feeding phase of its monetary policy. Every decision it makes won’t be well-telegraphed, making things tougher for investors. The direction of rates will depend on economic data. If inflation remains elevated and the data is hot, the odds for more rate hikes will be present, while the bar for rate cuts is much higher.

On Monday, we are anticipating the long-awaited senior loan officer survey at 2 PM ET, which will be important in determining whether banks are tightening lending standards. This survey will also help determine whether the credit crunch talked about on TV every five minutes is actually coming or not. If it is coming, it is well-disguised, as credit spreads don’t seem to be reflecting such a thing. This is especially true when looking at the high-yield credit spread index, which is still below 500 and has yet to make a higher high. It is also not visible in the VIX index, which tends to trade closely with the high-yield credit spread index.

On Wednesday, we are anticipating the April CPI reading, which is expected to show a year-over-year increase of 5% on the headline reading and a gain of 5.5% on the core reading. The crucial thing to watch, of course, is the month-over-month change, which is expected to show a gain of 0.4% on the headline and 0.3% on the core readings. Both of these numbers are too high to be consistent with a 2% inflation rate, and anything higher would create even more problems for the Fed, especially following the hotter-than-expected non-farm payroll report. Luckily for the Fed, they will get another job report and inflation report before the June FOMC meeting.

S&P 500 (SPX)

Since the end of March, the S&P 500 has been stuck between 4,100 and 4,200, and I still believe that the bulls are trapped around the 4,200 region. They have been unable to show the ability to push the index much higher, and the other problem at this point is that peak earnings season has passed. All of the big names that helped to lift the index higher are probably running out of steam at this point. Additionally, momentum based on the RSI is lower, noted by the lower lows and lower highs, which is a divergence from the higher lows seen in the S&P 500 index, since October.

This weakness is also illustrated in the weekly rate of change in the index, which is currently on the zero bound and appears to be heading toward the lower bound. This suggests a potential 200-point drop from current levels in the coming weeks.

NASDAQ 100 (NDX)

Meanwhile, the trading range in the NASDAQ 100 is getting tighter and forming a rising wedge pattern, with a bump-and-run pattern forming as well. The consolidation is more apparent in the RSI for the NASDAQ. This suggests that the NASDAQ will remain fairly trapped at current levels and is likely to head lower from here. However, it’s waiting for that decisive break lower.

META (META)

Meta shares, which have been one of the big leaders in 2023, are seemingly finally running out of steam. The stock has retraced 50% of its losses from its peak in 2021 and has managed to stall at resistance around $236, reaching the upper end of its trading channel. It still has a significant gap to fill down to around $212. If that gap was an exhaustion gap, which it appears to be, given the stock’s inability to rally further, then it should get filled soon.

Alphabet (GOOGL)

Meanwhile, Alphabet has seemingly run out of steam around $108 and has been unable to push through that resistance level. It appears to be running out of short-term momentum.

Tencent (700 HK)

Additionally, we have seen weaknesses start to emerge overseas, such as in Hong Kong technology names like Tencent. Tencent was a leader in the space off the October lows but has more recently turned sharply lower, despite the XLK technology ETF continuing to trend higher. Currently, Tencent is testing its lower support level with a drop below 332 HKD, which is a very clear negative for the entire global technology group.

That’s all, good luck this week.

Mike

Charts used with the permission of Bloomberg Finance L.P. This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.

This Week’s CPI Report Could Seal The Deal On The Next Big Rate Hike

by Michael Kramer

4/9/23

#STOCKS – $KRE, $CAT, $NVDA

#MACRO – $SPX, $NDX, #RATES

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The job report on Friday came in stronger than expected, and now this week, all the attention will shift back to the CPI and inflation report. The odds of a May rate hike have increased following the job report, and it won’t take much from the CPI report to seal the deal on the May 25 bps rate hike; it will only take an inline number on the core CPI reading. I say core because, at this point, core inflation is all that matters, given that it is expected to be the higher of the two values and is seen rising by up 5.6% in March, which would be hotter than the 5.5% reading in February. Overall, analysts have done a fairly decent job predicting the core CPI rate, so I would not expect much deviation from estimates when the number comes out on April 12.

The low unemployment rate and increasing labor participation rate make it more favorable to implement a 25 bps rate hike at this point. Therefore, any CPI reading that does not significantly deviate to the downside will likely confirm a rate hike in May. The probability of a rate hike has already risen to 70% following the job report, and most Fed officials have indicated that they want the Fed’s fund rate to be over 5%. Unless there is another bank failure, I do not see the Fed halting its efforts.

The NASDAQ’s (COMPQ, IXIC) entire movement has been based on the decline in real rates, and if rates begin to increase again, the NASDAQ is likely to decrease. The chart below demonstrates the inverted NASDAQ 100 versus the 10-year real yield, making it easy to observe the correlation between the two.

The number of new lows in the NASDAQ has consistently surpassed the number of new highs, indicating a divergence from the increasing composite for quite some time now.

If you examine the cumulative number of new highs minus new lows on a line chart, it can be a reliable leading indicator of the direction the NASDAQ composite is heading. In this case, a rising NASDAQ composite alongside a decreasing cumulative new high minus new lows suggests that the recent rally in the NASDAQ is not sustainable.

Moreover, the NYSE McClellan Ratio Adjusted Summation index has not indicated a significant upward trend. It has failed to surpass 0, with no signs of this occurring in the near future, marking a very weak rally attempt thus far.  A similar scenario occurred in March 2022, which resulted in a sharp decline in the S&P 500 in the following weeks.

The NASDAQ 100 (NDX) appears to follow the same path as in 2022. Whether this pattern will persist remains uncertain, but it has been the case since January 27.

There appears to be a persistent 40-day cycle in the S&P 500, which dates back to October 2021. More recently, this cycle has been associated with the job report and has marked a turning point for the index each month since at least November. If this month also marks a turning point, it would suggest that the index is likely to decline into May.

If the S&P 500 (SPX) does indeed turn lower, it could potentially create a head and shoulders reversal pattern. It’s important to be alert and monitor for this pattern.

This week, the 30-year Treasury rate may be the most important yield to monitor since it has reached the lower end of its recent range, and Fed policy has limited impact on it. There is a clear support level around the 3.5% mark that is critical for the 30-year rate. If it remains above this level, there is a possibility of further upside and potentially a new high. Conversely, if it falls below 3.5%, the opposite may occur, and there could be a steep decline.

Nvidia (NVDA) appears to have formed an inverse head and shoulders pattern, and if this is the case, then the objective has almost been achieved along with the retracement. Although the RSI has been steadily rising, it has recently flattened out and is now showing a bearish divergence by failing to make a higher high while prices have continued to do so. We will have to wait and see whether this marks the end of the NVDA rally. If it stops rising, it would be a logical place to conclude the unsustainable move higher.

Caterpillar (CAT) has experienced a sharp decline and has now returned to its support level at $209. The next level to be filled on its downward trend appears to be the big void at $198.

The regional banks will continue to be a focus this week, particularly as the KRE ETF (KRE) has broken down and is testing a crucial support level at $42. This is a significant level where the ETF has been consolidating. However, if it breaks this support level, it could trigger a downward trend toward lower levels at around $36.

If you wish to receive this commentary every day from Monday through Thursday, you can subscribe for $99 for the first year by visiting my newsletter on the Seeking Alpha website.

Have a good holiday weekend!
-Mike

Charts used with the permission of Bloomberg Finance LP. This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Past performance of an index is not an indication or guarantee of future results. It is not possible to invest directly in an index. Exposure to an asset class represented by an index may be available through investable instruments based on that index. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.