It’s a Sign… Maybe

One of the challenges of technical analysis is confirming a change in trend. It’s easy to spot after it’s happened. But spotting a trend change while it’s happening is a calculated risk. The data may indicate something, but the future is not written. So essentially, it’s a fancy rationalization of the future, a.k.a. a guess.

Looking at the current technical indicators, the trend looks like it’s changing. So we have to consider a handful of possibilities.

If it really is changing, why? What might explain this? Or are we simple wrong?

As Q1-2021 gets logged in the books this week, the S&P 500 and DJIA will have posted all-time highs on March 17th and 18th respectively. The NASDAQ, on the other hand, posted its all-time high back on February 16th.

The 10-year treasury yield has been climbing. The FOMC suggests it is not going to raise interest rates for perhaps another 18-to-24 months (presumably because of the unemployment numbers resulting from Covid).

When looking at the underlying trends in the market, it seems like the market is ahead of the Fed. We hear inflation is negligible — or that deflation may be an issue — but the tone from Washington, DC no longer fits that narrative. And the budget reconciliation process has created a path for spending legislation to make it to Biden’s desk. So the money printing, as far as the markets are concerned, is very likely.

The major indexes are starting to show it. Tech has sold off and banks have climbed. Why?

The moves fit the storyline of increasing inflation. The higher cost of capital will make it more expensive for big tech to go higher, but it will improve margins for financial companies.

There are more layers to it than that. But on the surface, it’s a plausible explanation that appears to be thematically taking hold in the markets. The riskier equity segments are increasing in volatility.

Take a look at the chart below:

S&P 500 projections for the week of March 29, 2021

Notice the light-blue line rising up and to the right? Notice the dark-blue line that changes to light-blue below it? The upper line was a projection of peak-to-peak market highs for 2021 so far this year. It established a kind of upper limit to the market expansion. A price move above this line would indicate some kind of break-out. No such move has occurred in months.

That upper line projected the SPX rising toward the mid-5000’s by year’s end. It was an unrealistic expectation. But it roughly reflected the price multiple of a 31-to-33ish forward PE for the index.

The new lower line projects out toward the 4600-4700ish range for the SPX. That’s still about a 15-to-18% move higher from current levels. But the forward PE would have to fall.

A few weeks ago we discussed this concept – the idea that earnings growth may continue higher for corporate America, but the headwinds of inflation and higher taxes could lower price multiples.

So far this explanation fits the technical behavior we see in the markets. Corporate headwinds don’t stop profits, but the relative future profits are impacted. And with the 10-year treasury climbing higher, many of the risk-relative pricing models are going to shift. At some point the behavior will likely follow.

For a long time the theme has been TINA – there is no alternative. Investors have been forced into equities because fixed income and other asset classes have had such low yields it didn’t make sense.

Well, in a rising rate environment, TINA may no longer be the case.

The tone in Washington is clear – spend more, accountability can come later. Regardless of your political leanings, economic reality cares not about the rhetoric. You could no sooner convince gravity to cease to exist. And you can not print money and simply demand it reflect the same purchasing power.

If money supply is going to increase, there must either be an increase in supply to maintain price stability, or you can expect prices to increase if supply remains the same.

Throw a pandemic shut-down in the mix to reduce supply (and some demand), then throw a bunch of printed money in the system. Hit the re-boot button… get some popcorn. Because that’s where we’re at.

As people get back to work, with a lot more money floating around in the system, and talk of another $4 TRILLION in government infrastructure spending, and it’s hard not to see inflation on the horizon. The question is simply a matter of when.

And the reality is, folks do not have a grounding concept of a trillion dollars. The numbers are so big it just sort of pegs the meter and folks go numb. Imagine taking all the income produced in a year from 1 in every 5 adults in the US. The number is bigger than that. So the math can get out of control in a hurry.

Bottom line: inflation is likely, and the beginning signs of multiple expansion seem to make sense. We’ll keep an eye on things.

For the week, look for sideways. The BigFoot Database is relatively unchanged at 59% long; the DJIA is the only major index with a buy; and the macros are in the green. It’s the end of the first quarter. Earnings season is just around the corner. And who knows what comes next from Washington? But vaccinations are happening and the economy is reopening. That should be enough to keep the wind from completely coming out of the sails.


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