Cue the rhetoric

Cue the rhetoric – start jawboning in 3, 2, 1…  The S&P500, Dow Jones, and NASDAQ took a well-deserved breather yesterday while the small-cap RUSSELL 2000 set its sights on recent highs.  The S&P500 still managed to close above the important 2800 level keeping the chart constructive as the index looks to consolidate before another attempt for the ceiling (see chart 4).  The important 2800 level and Fibonacci 2776 will serve as supports for the S&P.  The VIX index has been trading near the low end of established range between 12 and 18.  Remember that VIX index is an indicator of volatility and is often referred to as the fear index.  The index is derived from the implied volatility of the S&P500 futures options.  Its initial intention was to serve as a tool for traders to hedge their long equity positions and, for the most part, you may notice that it trades in the opposite direction of the S&P500.  But don’t try this at home folks, it is very difficult to actually calculate the hedging ratios and they change significantly when you might need them most, when the S&P sells off.  Despite this the VIX can be used a gauge of investor complacency, so when you see the VIX trading at the low end of its range for long periods of time, as it has for the past two weeks, it could mean that the S&P is due for a pull back, as complacency doesn’t typically last too long in equity markets.  However, to put things into perspective, a few weeks of complacency is nothing compared to the entire quarter of complacency that preceded the market trade- off that marked the beginning of 2017.  The Dow Jones Index managed to stay above its important 25000 level, which is positive however the chart still remains neutral until we see some closes above the 25495 Fibonacci line (see chart 6).  The Russell 2000 index managed to close just above its critical 1700 level and was the star in yesterday’s otherwise quiet day of trade for equities (see chart 7).  Expect the R2K to make a push above its 1708 Fib line and all-time high within the next few sessions.  The NASDAQ 100 took a breather yesterday, which is to be expected as it hit recent highs on a caffeine induced binge in the face of bad data from some of its key members.  These types of binge moves can be expected as the index’s drivers are primarily growth and momentum, which are typically not held accountable to anything but… investor excitement about the future (see chart 8).  Despite that, the NASDAQ remains constructive and a good earnings show by Google (which is due to report on Monday) can easily push the index to new highs.

Moving on to currencies, commodities, rates, and Presidential rhetoric.  One might think that a strong currency is a good thing.  First of all, what IS a strong Dollar?  A strong currency is one that is trading up relative to other currencies and occurs when traders are buying lots of a currency in order to purchase local sovereign debt.  In the case of the US Dollar, when foreign investors want to buy US treasuries, they will have to convert their currency to Dollars.  That means that they would be selling their own currency and buying the US Dollar.  This typically happens when one economy is strong relative to all others, such as the US economy relative to the slowing Chinese economy.  Another driver is interest rates.  When US interest rates are on the rise, yield seekers tend to move their money into the Dollar denominated US treasury market and they must convert their currencies to Dollars thereby strengthening it.  But there is a downside to a strong Dollar.  A stronger Dollar means that foreigners who wish to purchase US goods and services will have to pay more for them as the cost of currency conversion goes up.  Not particularly good for an America first policy and the President would prefer a weaker dollar.  Commodities have been weakened by a slowdown in the Chinese economy and speculation that their industrial output will be further hampered by the trade war.  China can be thought of as the poster child for global manufacturing and they are the largest consumer of raw materials, particularly metals and fuel.  The industrial metals complex remains in a weak state as can be seen by observing gold (which is an industrial metal) on chart 12 of my chartbook.  Now on to rates.  Low rates means cheap borrowing.  Cheap borrowing means economic growth.  Remember that rate policy is the gas pedal / break pedal of the Federal Reserve, whose job it is to control the growth, and slowdown of the US economy.  As the US Economy is humming along doing quite well, an unwanted side effect will ultimately be price inflation, which is the silent killer of economies and equity markets.  The Fed wishing to avoid pain in the future has been raising rates slowly in order to control growth.  Rate hikes will ultimately stop growth altogether and lead to a recession. Though this sounds bad, it is actually part of the economic cycle.  Now on to the President.  The President, who shamelessly takes every opportunity to take personal credit for this economic expansion (which started in 2009), would like to see the economy continue to grow and provide its benefits to the American people and his ratings, at least through the next Presidential election.  That said, Mr. Trump is no fan of a strong dollar and rising interest rates which are both natural dampers of the economy.  Cue the rhetoric.  The President has been having a tough week on the heals of his meeting with, now pal, Vlad Putin.  As is typical of his style, the President will turn up rhetoric and ignite his political base when he hits rough patches in order to shift the dialog.  And he did just that yesterday in an interview in which he criticized his anointed Fed Chair Jerome Powell on interest rate policy.  It was just a matter of time, but in light of a tough press week the Fed was a low-hanging fruit.  What is interesting is that Fed Funds Future and bonds, for the most part, completely ignored the jab.  Rates traders are typically less concerned with rhetoric, which is why many believe that fixed income is the ultimate predictor of things to come (more on that in future notes).  WHILE YOU SLEPT:  China decided not to intervene in its currency’s slide (see chart 14) despite much speculation that they would.  Wonder why they might do something like that?  Re-read the top part of this paragraph and recall that we are in a trade war with China.  Futures markets initially fell and ultimately bounced back.  Not before some more rhetoric came in the form of threats to go to $500 billion in tariffs by none other than @realDonaldTrump causing futures to slide once again.  Today will be a test of equity market resilience.  Will they respond to the jawboning, or are they growing immune to the rhetoric?  It should be an interesting one to watch… from the sidelines at least.  Have a great weekend and please call with any questions.

daily chartbook 2018-07-20

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