Fiscal Fade, Fed Fear, Sinks Stocks

For most of 2021 analysts and economists excoriated the Federal Reserve incessantly for failing to stop stimulating supply chain inflation and start raising interest rates. Stock investors even rewarded the prospects of reducing stimulus with higher stock prices when Fed Chair Powell finally complied with pundits, changing his feathers from Dove to Hawk with a pivotal monetary tightening beginning in November 2021. Although Tech indices began to underperfom as of November, due to rising interest rates, the broader markets continued to new record highs during the very positive Seasonal bias through the end of December. As Seasonal strength ended in early January, money managers showed their fickle nature in raising alarm bells that the Fed might raise rates too quickly. This new sentiment at the Wall Street Fashion Show has further accelerated the concern over Tech stocks with the tech heavy Nasdaq (QQQ) falling a whopping 10% from its record highs while the benchmark SP 500 Index and Dow Industrials corrected just 5% and 3% respectively. Many reopening, energy, industrial and emerging market stocks have actually risen during this broad market decline.

The most popular measure of US stocks, the S&P 500 Index, is often analyzed technically by its 50 and 200 day moving average (dma). Throughout this enormous 22 month Bull market the 50 dma has essentially held that support. Since early December, the 50 dma has been tested with unusual frequency, 4 times. Often key supports such as this are tested several times in a short period and follow through with a more decisive breakdown on the 4th violation. Each of these drops have been about 5% from all time highs and should the current downwave sink below this support, the new price magnet pundits will zero in upon will be a zone around the 200 dma in the lower 4,400’s. As seen below, the 200 dma would be just over an 8% total correction from the recent record highs set on January 4th at 4818. In the context of a Bull market that has soared 118%, an 8 to 10% decline is modest, but it will be greeted with extreme fear with investors conditioned to assume that prices can only go up sharply. The outsized average gains of 18% in each of the past 3 years and 27% in 2021, have trained investors and managers to start buying upon every dip to the 50 dma. At some point this easy buy strategy fails and with the fading prospects of new Fiscal stimulus through “Build Back Better” and the rapid ramp up of monetary restrictions by the Fed, a much needed transition to a period of weaker equity trends may be upon us.  New buying will ensue once we approach and perhaps exceed the 200 dma, with a focus on in store retail, industrial, banks, financial, travel, energy and emerging markets instead of mega cap tech. The main tech sector focus worth continued buying on dips should be semiconductor chip and equipment/service related stocks.

Markets look for news oriented excuses to trigger trends that were destined to occur anyway and the fear of the Fed clamping down on inflation has been that ‘Sell the Rumor’ moment. Our early January forecast for a low near the 50 dma was on target, sparking a sharp 3 day rebound from the lows. The amplitude of that rally projected down from the January 10th lows at 4573 coincidentally targets the exact 200 dma of the cash SP at 4417  (as of 1/13/22).  There should be a nice market rebound from whatever low is registered in the 2nd half of January – early February time frame and it would not be surprising to see the SP test the 200 dma zone or lower in the first quarter. Normally when markets test a popular support level such as the 200 dma and the 10% correction level they plunge through decisevly but briefly in order maximize Bearish sentiment and wash away weak hands that tried to hold on for a rally from these magnetic support zones.

In 2021 we prematurely assumed Covid would finally be suppressed and Government mandates removed, causing the Dollar to decline and emerging market (EM) and domestic reopening/travel stocks to soar. Despite the less impactful Delta wave and especially the very non lethal Omicron wave today, mandates and economic restrictions have only escalated. Virus cases have far surpassed all previous waves, yet for the first time fatalities continue to fall. This supports our recent report that this fear phase will be short lived and that mandates will more permanently ease in coming months, barring the shock of a new more deadly strain of Covid. As can be seen with the Emerging Market (EM) index below, the Dollar rose and EM stocks declined throughout 2021 as Covid raged in countries with poor healthcare. The low risk exposure to the dominant strain of the Omicron virus has recently pushed the US Dollar lower and small country stocks higher on the long awaited reopening trade. Supply chain inflation still has a long way to go, but if current trends continue and economic risk abroad declines, then capital flows will move away from the US into EM’s and push our Dollar lower, EM stocks higher.

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