Hello traders
I hope you’ve all had a good week!
The good news seems to keep on coming for equity bulls, with positive surprise seen in key consumer data this week. Despite these inflationary pressures though, speculators also bought bonds, which added further fuel for the rally in stocks, supported by tech companies yesterday. From what I have read, it seems likely that the move in bonds was technically-driven by the hedge funds rather than the ‘slow money’ (mutual funds), following their extremely short positioning. As such I tend to believe the stock market’s reaction to the data more than the move in bonds, which could well reverse in the coming days (after all, the prospect of rising inflation is a very clear reason to sell bonds, historically).
Putting aside the differences between the two tribes, President Biden’s stimulus bill continues to underpin the rally in risk markets. On this basis, the market expects a broader economic recovery which already appears to be progressing with the improvement in our Business Cycle Checklist on last month.
The score increased from +1.5 to +2.5 this month, and sets the tone for the longer-term economic outlook. This in my view validates the normalisation in interest rates which the bond market has been anticipating (before yesterday’s uncharacteristic reaction), but also very much supports a continuation of the bull run in stocks.
We are however at the beginning of earnings season in the U.S., with many of the major banks getting things underway this week. Only time will tell how the multitude of reports are received by investors, and what baring this may have on the likes of the S&P 500 Index in the weeks ahead. Looking to the chart you can see just how strong equities have been recently, although there are a couple of conditions that technical analysts might highlight as potential warning flags for a correction – particularly if there is a catalyst in negative earnings surprise.
Whilst there is the potential for some profit-taking in the very near-term, with the daily RSI “overbought” around a key Fibonacci retracement level, we should of course give primary consideration to what our Checklist is telling us. Compared to last month it has actually weakened to a score of +0.5 which still suggests a slight bullish bias. It does however offer a note of caution to not ahead of ourselves this month as the strong momentum we have seen may begin to subside without a further catalyst. Despite everything seeming to favour of equities at the moment, ‘second-level thinking’, as Howard Marks puts it, suggests that what is already known to the market may not be enough to sustain the extreme move in price.
On a less cynical note, I thought we could finish with a look at our currency Checklist for the US dollar. As I discussed with Trading Club members in this week’s video analysis, FX has been a good area for finding profitable trade ideas this month. Having seen a recovery from a low of almost 89 at the beginning of the year, the US dollar index (DXY) looked prone to a correction as April began with a negative score on our Checklist.
This hourly chart shows how the gravity of the fundamentals became irresistible and correctly anticipated the decline from a level of 93.40 to 91.50 currently (approximately -2%). This has had a profound effect on the other currency pairs that we also follow, which we may have more time to discuss here next week.
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Have a great weekend,
James
