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The cornerstone of my Tactical Strategy is the intersection of Economic Fundamentals, Monetary Policy, and Technical Analysis. The combination of these has helped me implement an effective Tactical Strategy that seeks to identify investment opportunities in the stock market, Treasury Bonds, Gold, Gold stocks, and the Dollar.
In the Weekly Technical Review and the monthly Macro Tides I review recent economic data and how that data fits into the overall economic framework. That framework allows me to provide insight into FOMC monetary policy which is often the most important influence for the stock market, Treasury yields, Dollar, foreign equity markets, and Gold and Gold stocks.
There are few strategists that have the experience, knowledge, and combination of skills to help you navigate the financial markets. I am one of them. If you read my analysis I think you’ll agree with that assessment.
The FOMC and Inflation
In 2021 I didn’t think inflation would be transitory as Chair Powell believed. The monthly titles for Macro Tides from June 2021 through June 2022 highlight why inflation was expected to keep rising. In June 2022 the Consumer Price Index reached 9.1% and a 40-year high.
On January 12, 2022 Chair Powell told members of Congress that inflation was a severe threat. Despite this statement Wall Street believed the FOMC would increase the Funds rate only 3 times in all of 2022 (Federal Funds Rate Futures, Goldman Sachs). In the January 17, 2022 Weekly Technical Review I noted that financial markets were underestimating how the FOMC was likely to respond to the surge in inflation. “Powell described inflation as a ‘severe threat’ and most people when confronted by a severe threat don’t react moderately. The FOMC is likely to move more aggressively than the markets expect.” I told subscribers that the FOMC would front load the change in monetary policy with 3 consecutive increases at the March, May and June 2022 meetings. As noted in the January 17 WTR, “By front loading rate increases by raising the funds rate in March, May, and June, the FOMC can lower the risk of staying behind the curve and ultimately being forced to raise rates too much in the second half of 2022 and first half of 2023 to play catch up.” The stock market declined sharply in the first half of 2022 since Wall Street was surprised by the FOMC’s aggressiveness.
In September 2022 inflation was 8.3% and showing no signs that it would come down quickly. In the October 2022 Macro Tides I explained why “Inflation Relief Is Coming” and that inflation could fall from 8.3% to 4.4% in March 2023. “The CPI and the PCE indexes are largely a function of a 12 month rate of change. The monthly increase from September 2021 is subtracted from the annual increase, and the monthly change for September 2022 CPI is added. The math makes it possible to know how much will be subtracted from the CPI in the next 7 months with certainty. The take away value for the next 7 months (September-March) is -5.25%. The table estimates what level the headline CPI will be if the coming monthly increase is 0.1%, 0.2%, or 0.3%. If the monthly increase averages 0.2%, the November CPI would be 6.5% when it’s announced the day before the FOMC meets on December 14. The March 2023 CPI could be 4.41% when it’s announced in mid April.” The monthly increase in the CPI averaged 0.3% and fell to 5.0% for March 2023 as the table indicated. The large decline in CPI inflation caught many by surprise.
I thought Wall Street would misinterpret the large decline in inflation and jump to the wrong conclusion. “As CPI inflation comes down many on Wall Street will jump to the conclusion that the FOMC will pivot and begin lowering interest rates.” I disagreed as noted in the October 2022 Macro Tides with emphasis. “The coming decline in inflation will give the FOMC the cover it needs to stop hiking rates aggressively, but not pivot and lower rates.” After increasing the Funds rate by 0.75% at the November 1 FOMC meeting, the Funds rate was increased by 0.50% at the December 14 meeting, and 0.25% at the February 1, 2023 meeting.
In the January 2023 Macro Tides I discussed why the CPI could fall from 7.1% in November to near 3.0% in June 2023. “The total monthly take away value for headline CPI inflation from January 2022 through June 2022 for the first six months of 2023 is -5.32%. If monthly CPI inflation averages 0.2% during those 6 months, the headline CPI could drop to 2.5% or 3.5%, if the monthly average is 0.3%.” On July 12, 2023 the CPI for June 2023 was reported at 3.0%.
Many economists were seduced into believing a recession had begun in the summer of 2022 after GDP contracted in the first and second quarter of 2022, as noted in the August 8, 2022 Weekly Technical Review. “Wall Street is convinced the economy is already in a recession (after all 2 consecutive quarters of negative GDP = Recession, irrespective of trade, inventories, strong job growth, and decent consumer spending), or will be in a recession forthwith.” In the August 2022 Macro Tides I discussed in more detail why the simplistic two consecutive quarters of negative GDP meant recession wasn’t applicable in 2022. “The reason for the inconsistency between the 2 consecutive quarter ‘rule’ and previous recession determinations is that NBER uses a broader array of economic data than simply two consecutive quarters of negative GDP. NBER’s eight-member business cycle dating committee includes a range of monthly and quarterly data points, including output, income, manufacturing activity, business sales and, importantly employment levels. Then it makes a judgment call. “A recession is a significant decline in economic activity spread across the economy, normally visible in production, employment, and other indicators.”
“In the first quarter (2022) 1.57 million jobs were created. Although employment is a lagging indicator, the first quarter’s monthly job growth of 392,000 would be more associated with a booming economy rather than a recession. To put this number into perspective, average monthly job growth in 2019 was 164,000. No way there was a recession in 2019. The ONLY reason GDP was negative in the first quarter was Trade (Net Exports) which subtracted -3.2%. In order to arrive at Gross DOMESTIC Production, the Bureau of Economic Analysis (BEA) subtracts production outside the US. In the first quarter the US trade deficit reached an all time high as US consumers bought a boat load of goods that were produced overseas. The BEA subtracted Imports from domestic output, which lowered GDP by -3.2% producing a -1.6% drop in GDP. Trade is an accounting measure that most people don’t understand, are too lazy to investigate, or prefer to simply rely on the two quarter rule for whatever reason. A review of economic data beyond GDP indicates the US economy didn’t contract in the first quarter, so the declaration of a recession is premature.”
One of the factors that convinced economists that a recession would hit in early 2023 was the sharp decline in the New Orders Index within the monthly ISM Manufacturing Index. New Orders have been a good recession predictor since 1990. When New Orders began to contract (orange line below 50 in the ISM survey) a recession (shaded areas) subsequently ensued.
As I discussed last year consumer spending shifted in 2022 from buying goods during the Pandemic lockdown to spending on services as the economy opened. Since Services comprise almost 80% of GDP compared to less than 15% for manufacturing, the decline in New Orders didn’t carry the same recession message it had in prior cycles. When New Orders fell convincingly below 50 in September (reported on October 1) and then held well below 50 in October, November, and December, the recession debate for many economists was sealed. This is why a recession was expected in the first quarter of 2023. Ironically, the New Orders Index has remained below 50 and in May was 42.6 and still no recession has taken hold.
In the February 2023 Macro Tides I reviewed why a recession wouldn’t take hold in the first half of 2023. “Consumer spending represents almost 70% of GDP and is being sustained by the lowest Unemployment Rate in 53 years and gains in wages. Although Average Hourly Earnings were up 4.6% that number understates the actual increase. According to the Labor Department, Median weekly earnings for all workers were up 7.4% in 2022. The bottom 10% of wage earners experienced a 10% increase, so they benefitted more than any other group. The increase in wages is helping consumers stretch the Excess Savings they accumulated during the Pandemic.
In order to cut down on turnover, many companies are increasing wages to prevent good workers from going to a greener pasture. Walmart announced that it was increasing pay from $12 an hour to $14 (16.6%), for 340,000 of Walmart’s 1.6 million workers starting in March. On January 1, the minimum wage was increased in 26 states, which will result in income creep for workers earning just above the minimum. Since 2015 the percentage of workers earning more than the minimum wage has climbed from 12% to 33%.
On January 1, 66 million Social Security recipients received a pay increase of 8.7%, which amounts to an increase $9.7 billion in monthly income. In 2023 Social Security will disburse $116 billion more than in 2022 that will help seniors sustain their spending.
Most Consumers are in good shape. They still have a healthy cushion of Pandemic savings, wage growth is solid, the labor market is resilient, and the Unemployment Rate is historically low. A year ago the return on savings was 0%, but consumers can now earn 4% or more and actually generate real income.”
In November 2021 the CPI jumped to 6.8% which represented a 39 year high. Chair Powell was forced to finally acknowledge that inflation wasn’t going to be transitory after all. On December 9, 2021 the Federal Funds Futures were pricing in 3 increases of 0.25% in all of 2022, even after Chair Powell’s comments and a 39 year high in the CPI. Talk about being wrong! I thought Wall Street would be surprised when the FOMC proved more aggressive and expected the S&P 500 to decline by 10% in the first quarter. As inflation pushed higher in 2022 I expected the FOMC to keep hiking the Funds rate which would compress the S&P 500’s P/E ratio.
December 2021 Macro Tides - “The stock market could be vulnerable to a correction of -10% or more in the first quarter if markets expect the FOMC to move more aggressively in the first half of 2022.” The S&P 500 dropped from 4818 on January 4 to 4115 on February 24 a drop of -14.6%, and down -13.6% from December 31, 2021.
April 4, 2022 Weekly Technical Review - Investors were advised to lower equity exposure as the S&P 500 was trading near 4600. “From a risk reward and risk management perspective, raising cash as the S&P 500 trades near 4600 is a good idea. If this has been nothing but an impressive bear market rally, the S&P 500 will likely test 4115, or trade down to 3850 if 4115 doesn’t hold.” The S&P 500 dropped to 3850 on May 20.
September 19, 2022 Weekly Technical Review - A decline to the June low was expected after any bounce in response to Chair Powell comments after the September 21 FOMC meeting. “Unless Chair Powell throws the market a glimmer of hope, the FOMC projections and Dot Plot could hurt, as the FOMC lowers the estimate for GDP growth, increases its estimate for Unemployment and inflation, and indicates that the Fed Funds rate is going higher for longer.” The S&P 500 could rally to 4150 – 4200 in the next few weeks. Once this rally is complete, a decline to the June low of 3637 is expected.” The S&P 500 fell to 3584 on September 30.
I expected inflation to decline by more than most investors expected through the first quarter of 2023, as discussed in the October 2022 Macro Tides. The stock market was deeply oversold and investors were bracing for a recession. I didn’t think a recession would develop in 2022 or in the first half of 2023.
In the October 17, 2022 Weekly Technical Review the S&P 500 was expected to rally. “The current pattern suggests the S&P 500 can rally to the underside of the blue trend line near 4050. If the CPI comes in less than 8.0% for October on November 10, and a number of FOMC members subsequently come out in support of tempering rate hikes leading up to the December 14 meeting, the S&P 500 could approach the mid August high of 4325.
In the February 13, 2023 Weekly Technical Review I discussed how bullish sentiment had climbed to a high level. “Sentiment has changed significantly since the low in October. For instance, in October the allocation to equities by the National Association of Active Investment Managers (NAAIM) was less than 20%. Last week the allocation exceeded 80% which is higher than at any time in 2022.” The expectation was that a pullback to “could bring the S&P 500 down to 3980 – 4015 (January 30 low).” As the Regional bank crisis erupted in early March the S&P 500 dropped to an intra-day low of 3808 on March 13.
In the April 17, 2023 Weekly Technical Review I reiterated the expectation of a rally above 4195 on the S&P 500. “A rally above 4195 remains likely. If Wall Street pushes the pause button as being bullish, the S&P 500 could approach the August high of 4325. The 61.8% retracement of the decline from 4818 to 3492 is 4311.” In every WTR in May, the S&P 500 was expected to rally above 4200 as economy held up, the Debt Ceiling was increased, and the FOMC signaled that it would pause after hiking the Funds rate to 5.0% to 5.25% at the May 3 meeting.
July 10, 2023 Weekly Technical Review “The Consumer Price report on July 12 will be good news and is expected to allow the market to rally. The S&P 500 has the potential to reach 4520 the QQQ could test 380, with the Russell 2000 up to 1950.” The S&P reached 4528 on July 14.
In the July 2021 Macro Tides I reviewed why the technical chart pattern of the Dollar suggested that it had formed an important low in June, after completing a correction that began in January 2017. This was discussed repeatedly in the Weekly Technical Reviews in May and early June 2021. This excerpt is from the June 7 WTR. “The expectation is that the Dollar will fall below its January 4 low of 89.21 to complete wave 5. The big news is that the coming low may be the end of the correction that began after the Dollar peaked in January 2017 at 103.82. Wave A of the correction lasted from January 2017 until the Dollar bottomed at 88.25 in February 2018. Wave B of the correction carried the Dollar up to its high in March 2020, with Wave C now near completion. The price pattern suggests the Dollar has the potential to rally above 100.00 in the next 12 months.” The Dollar traded up to 105.00 in May 2022.
In October 2022 I thought inflation would drop significantly through the first quarter of 2023 and cause the Dollar to fall from 114.00 to under 105.00 in the first quarter of 2023. This was discussed in the November 2022 Macro Tides. “In June 2021 I thought the Dollar was bottoming near 90.00, based on technical factors and the expectation that the Dollar would rally, as the FOMC moved from accommodation to increasing rates. In coming months, the FOMC will move to slow the pace of its tightening and ultimately stop increasing the Funds rate at the Terminal Rate. The Dollar will weaken anew if the October CPI sports a 7 handle. As long as the Dollar doesn’t close above 112.75, the expectation is that the Dollar will close below 109.20 and drop to 105.00 in the first quarter of 2023.” The Dollar fell to 100.82 on February 2. In the January 30 Weekly Technical Review the Dollar was expected to bounce and retrace a portion of its large decline. “The Dollar is expected to rally to 106.50 – 108.00 in coming months. A close above 102.50 will be the first indication that a trading low has formed.” The Dollar rebounded to 105.88 on March 8.
In January 2021 I expected Treasury yields to move up before inflation became a real problem based on the chart patterns for the 10-year and 30-year Treasury yields. This was discussed in a number of Weekly Technical Reviews during January 2021 and summarized in the February 2021 Macro Tides. “As discussed in recent Weekly Technical Reviews “The 10-year Treasury yield is expected drop to 0.95% before climbing to 1.266%. If the headline CPI news sends a shiver through the bond market, the 10-year yield will test and likely breakout above 1.266%. At some point in 2021, more likely in the second half of the year, the 10-year Treasury yield could spike up to 1.75% to 1.95%.” The 10-year yield reached 1.765% on March 30.
In the second half of 2021 Congress failed to increase the debt ceiling which meant the Treasury couldn’t issue new government bonds. The lack of supply helped support Treasury bond prices and monthly QE purchases of Treasury bonds kept Treasury yields below their March 2021 peak.
The suppression of Treasury yields was expected to end after Congress increased the debt ceiling in December 2021 and the FOMC ended its QE purchases in March 2022 as noted in the January 2022 Macro Tides. “Congress increased the debt ceiling in December and the Federal Reserve is slashing its purchases from $80 billion to zero in March 2022. The supply – demand imbalance is in the process of swinging from very favorable to the Perfect Storm, as the inflation news gets worse. As noted in the December Macro Tides, “Once the current decline in Treasury yields ends, Treasury yields are expected to surge above the March highs of 1.765% on the 10-year and 2.505% for the 30-year Treasury.” On January 3 the 10-year Treasury appears to have broken out to the upside so the trend toward 1.765% has begun. Additional confirmation is coming from the 30-year Treasury yield which also broke out on January 3. Longer term, the low yield in the 10-year was 0.504% in August 2020 just before rising to 1.765% an increase of 1.26%. An equal move higher from 1.128% would target a rise to 2.388%. This suggests that the odds favor that the 10-year Treasury yield trading above 2.0% in 2022. The 30-year Treasury yield recorded a low of 1.126% in April 2020 and subsequently moved up to 2.505% in March 2021, an increase of 1.379%. An equal move from the recent low of 1.678% would target a rise to 3.057% at some point in 2022.” The 10-year yield soared well above 2.388% as Wall Street realized the FOMC would be more aggressive than expected.
In the April 2022 Macro Tides I discussed why the FOMC would need to act forcefully since inflation was headed higher. In June the FOMC increased the Funds rate by 0.75% the largest increase since 1994. “What is overlooked is that in the past the FOMC could remain accommodative since its preferred inflation measure, core Personal Consumption Expenditure Index (PUC), held below its 2.0% inflation target for most of the last 25 years. With PCE inflation soaring to a 40 year high (5.4%), the FOMC knows it must act quickly and forcefully to prevent inflation from becoming embedded in consumer’s behavior and corporate pricing models. The longer this inflation surge persists consumers will demand higher wages and accelerate purchases to avoid future price increases. And Corporations will continue to pass along cost increases, until consumers and other businesses say No Mas!”
A number of factors came together in October that suggested Treasury yields could fall significantly. To offset the Dollar’s strength in the summer and fall of 2022, some Central Banks were forced to sell a portion of their Treasury bond holdings so they could sell the Dollar and strengthen their domestic currencies. Inflation was expected to fall sharply by the end of the first quarter, the technical pattern in the Dollar suggested it was set to drop from 114 to 105, and Treasury bonds were oversold. This was discussed in detail in the November Macro Tides. “As of October 21, Treasury bond prices had just declined for 12 consecutive weeks for the first time since 1977. There is evidence indicating that some of this extreme weakness was due to Central Banks selling Treasury debt, so they could support their domestic currency. If the Dollar stops going up, or better yet falls, Central Banks won’t have to continue to sell Treasury debt. The expectation is that the 10-year Treasury yield could fall to 3.50% at a minimum, and possibly to near 3.0% in the first quarter of 2023.” From a high of 4.223% on November 3 the 10-year Treasury fell to 3.253% on April 6, 2023.
After peaking in August 2020 I thought the down trend in Gold would take it below $1700.00 and possibly as low as $1660.00 as reviewed in the February 2021 Macro Tides. As noted in recent Weekly Technical Reviews, “Gold is expected to fall below $1766 and could fall to the down trending line that connects the low in August, September 24, and November 30 which is near $1720. Although unlikely, Gold could fall to $1660 during a spike low. Gold dropped $304 from the high of $2070 to the low of $1766 (Wave a?), before rebounding to $1960 (wave b?). An equal decline would bring Gold down to $1656 (wave c?) If and when Gold does fall below $1766, the manner in which it does so will provide some clues as to whether the trend line at $1720ish will be support.” Once this correction is over, Gold is expected to rally above $2070, and a CPI printing above 3.0% could provide the necessary juice. On March 8, 2021 Gold traded down to $1678.
In the February 14 2022 Weekly Technical Review I thought Gold would rally to $1900 before the prospect of higher interest rates created a headwind. “As discussed last week, “My guess is that Gold will at least test $1835. A breakout above $1850 should lead to higher prices (possibly $1900).” Gold finally broke out above the declining trend line that has formed the upper boundary for the triangle. This certainly increases the odds that Gold will test the June high near $1915. Beyond this I’m not sure. As noted last week it’s hard to see how Gold will ignore the shift in global monetary policy that has just begun. Gold’s RSI is already up to 69 so a decisive and sustained breakout above $1920 seems unlikely.” After Russia invaded Ukraine Gold zoomed to $2065 on March 8, 2022 before succumbing to higher interest rates.
As I expected, the prospect of higher interest rates lifted the Dollar and weighed on Gold as noted in the April 25, 2022 Weekly Technical Review. “Gold was able to rally even as the Dollar moved higher, until April 19 when the strength in the Dollar proved more than Gold, Silver, and Gold stocks could take. From a high of $1997 on April 18, Gold dropped to $1893 on April 25 and barely above the March 29 low of $1892. Although Gold held above the near term trend line today, the degree of weakness since April 19 opens the door for a drop to under $1840. Gold declined $164 from $2066 to $1902 and an equal drop from $1996 would bring Gold down to $1832.” Gold dropped to $1792 on May 16, 2022.
In the July 11, 2022 Weekly Technical Review I discussed Gold’s chart pattern and why a decline below $1720 could occur before the decline from the March 2022 high was complete. “As noted last week, Gold is nearing the end of the decline from the high of 2066 in March. “From the March 2022 high at 2066 Gold has now fallen in 5 Waves, with the recent drop from 1867 being Wave 5. However, Wave 5 is also breaking down into 5 Waves, and so far only Waves 1, 2 and 3 have unfolded, and Wave 3 of Wave 5 may not be complete. After topping at $2066 Gold fell $164 before making a low at $1902 for Wave 1 of Wave 5. If Wave 5 of this decline is equal to Wave 1, Gold could fall to $1713 and $164 below the Wave 4 high of $1877. If the Dollar continues to run, Gold could drop under $1720 before the decline is done.”
In October 2022 I expected the Dollar to top and then undergo a large correction. If that occurred, Gold was expected to rally significantly. This was discussed in the October 10, 2022 Weekly Technical Review. “Gold rallied from a low of $1616 on September 28 to $1728 on October 4. The 50% retracement of the $112 rally is $1672 and the 61.8% retracement is $1659. Gold dropped to $1666 on October 10. Gold could correct more if the Dollar rallies to a higher high. Gold is still expected to rally to $1800, and potentially higher once a top in the Dollar is confirmed.”
Gold has historically been touted as an inflation hedge but didn’t in 2022, even as inflation roared to a 40 year high in 2022, as noted in the November 14, 2022 Weekly Technical Review. “It’s a bit ironic that Gold rallied on a decline in inflation, since it’s considered to be an inflation hedge in portfolios. Gold reached $2070 in August 2020 when headline CPI inflation was 1.3%, and subsequently fell to $1616 as CPI inflation soared to 9.1%. This is why technical analysis must be incorporated when looking at Gold.”
The 5 wave rally from the September 2022 low of $1616 to $2059 on May 4, 2023 suggests that Gold will rally to a new all time high but first suffer a Wave 2 correction. This was explained in the May 8, 2023 Weekly Technical Review. “Near term Gold is expected to retrace a portion of the Wave 1 rally from $1616 to $2059 for wave 2. Gold should fall to $1900 - $1920 at a minimum. The 38.2% retracement would bring Gold down to $1865 - $1890, with Wave 4 of lesser degree at $1810. Gold rallied for 30 weeks so wave 2 could last 8 to 12 weeks. The 5 Wave rally from the September low of $1616 (large red numerals) suggests Gold will rally to a new all time high in Wave 3, after the Wave 2 correction runs its course.” Gold traded down to $1894 on June 29, 2023.
Thank you for reviewing the analysis I have provided subscribers. Hopefully your understanding of how the intersection of Economic Fundamentals, Monetary Policy, and Technical Analysis has helped me identify investment opportunities in the S&P 500, Dollar, Treasury Bonds, and Gold has convinced you that I have the experience, knowledge, and combination of skills to help you navigate the financial markets.
Linked In Jim Welsh - Twitter @JimWelshMacro