What prompted the market rally?
There are various drivers of the positive action.
1. Oil prices have been falling quite steeply (see chart below). This will help take pressure off the escalating inflation picture.
After hitting a high of $120 a barrel in June, oil prices have declined by about 30% to the low $80's. Some of this is due to seasonality, demand destruction (people are not driving as much), and a global slowdown (especially in Europe) which has caused additional supplies to come online.
As you can see in the chart above, the price of oil is now below both the 50 and 200-day moving averages. In fact, the 50 crossed below the 200 on Friday, which is viewed as a negative indication for future oil prices.
Oil's trend is bearish, but this has helped relieve some inflationary pressure which in turn is a net positive for the stock market.
2. Many commodities have declined in price (see a chart of DBC below). DBC is an ETF that tracks a basket of commodities, including oil and gas, softs (i.e., corn, soybeans, wheat, and sugar), gold, silver, and industrial metals (i.e., copper, aluminum, and zinc).
Materials such as copper and lumber have fallen due to the sharp decline in housing construction.
3. Interest rates have had a volatile summer. 10-year Treasury bond rates peaked in mid-June, then pulled back substantially (which spurred the June to early August stock rally).
After Fed Chairman Powell's infamous breakfast remarks at Jackson Hole in late July, the 10-year interest rate rose quickly again (see chart below).
During the last three days of the week, bond prices consolidated, which benefitted the stock market.
4. An oversold stock market which was due for a bounce. Many of the sentiment readings were extremely negative, and the momentum indicators (RSI) were also deeply oversold. As a result, it was not surprising to get a significant bounce after 3 negative weeks.
5. Transportation, small-caps, and retail stocks, all important members of Mish's Modern Economic Family, have held up above their all-important 50-day moving averages. This has signaled a potential bounce coming.
What conclusions can we derive from all of this? None, zero, zilch!!!
Headwinds Remain
We remain in a bear market (or at least not a NEW bull market).
We remain in a difficult market period of the year (September-October).
What are the other headwinds that potentially lie ahead?
- The upcoming midterm elections. Anticipation of one party or another having control of Congress may derail the markets. This midterm cycle has typically signaled a difficult period before November. Given the divisive nature that exists today, this could be exacerbated this year by the aggressive jawboning that takes place.
- Upcoming Fed meeting later this month. It is widely expected that the Fed will raise rates 75 bps (third month in a row for this steep of a raise). However, if they only raise 50 bps (not likely), it may signal to the markets that the economy is decelerating much faster than expected.
- Hawkish Fed Speak. Several Fed Governors have been actively commenting about the need to keep tightening. Most have said interest rates must continue going higher to stop inflation. This is likely to continue leading up to their next meeting in late September. This will continue to have an influence on market activity, good and bad.
- Negative macro-economic numbers Upcoming CP, ISM, Consumer Sentiment readings, indications of third quarter GDP, jobs numbers including unemployment claims, and a host of other indications of the strength or lack thereof of the economy.
- Recent large flows of money out of the stock market. Some funds, like ARKK (Ark Technology Fund) have seen record number of outflows during the month of August.
- Geopolitical surprises and inflation. Oil and natural gas are just a few of the pawns being used as countries try to control other countries. Meanwhile, soft commodities are still strong and could be in a longer-term Supercycle. Gold, silver, and industrial metals are also poised to rally from their near 100-year lows relative to equities
- Chinese aggressive action. US-China relations are not positive right now. This could impact our reliance on goods and services from the Far East.
- Dollar strength. This has already curtailed large multinational companies' earnings growth. This alone should drive earnings down and negatively affect the markets.
- Downward revised earnings expectations. Analysts have been cutting their corporate earnings expectations due to a combination of higher fixed and variable costs (materials and labor), a slowdown in consumption, and dollar strength which lowers export expectations. Problems in Europe are also having somewhat of a contagion effect.
- Potential housing slowdown. While not yet a "crash," housing activity is down significantly. This is due to higher interest rates and bubble-like housing prices in many markets, making housing increasingly unaffordable. If this area of the economy picks up speed, it will have a detrimental effect on consumer spending and, ultimately, investing in the stock market.