Momentum to pick up after US Labor Day holiday

Abraham George Macro View

Sep 06, 2020

First things first. Superstar Messi will continue to remain with Barcelona for one more year. He created a minor earthquake recently when he announced, that he may be moving out of Barcelona but considering all the bitter legal disputes that can rise he decided to stay put . He is still at loggerheads with the management. But Barcelona fans can still continue to watch his magic for one more year. Now to less serious matters.

Markets have been extremely volatile last week but before we get to all that let’s once again take stock of what was really communicated by the Fed Chairman at the very important Jackson Hole symposium.

All along the Fed has followed a dual mandate to pursue two main goals. Stable prices and maximum employment. The conundrum Fed faces is that both these forces are in opposite directions.

If unemployment falls too low and if companies can’t find enough workers , wages rise , then prices rise and inflation accelerates. If they decide to control inflation by raising interest rates , they will end creating unemployment.

So balancing these two equations is an enormous task that the Fed is challenged with. However there was a change of communiqué from Fed Chairman Powell last week.

Powell said that the Fed will shift the inflation- employment balance decidedly in favor of increasing employment, to the detriment of controlling inflation.

Instead of holding on to the 2% target ceiling in inflation, Powell and his team will now shoot for an average inflation rate of 2%.

The word “average” is very tricky. If you put your head in the freezer and your two legs in the oven you should have a pretty good average ‘room’ temperature but only you know, how you feel about it.

In recent years, the Fed has fallen far short of its 2% inflation target in most months. So to get the average rate up to 2% it will now be willing to see inflation overshoot in some months - may be by a lot.

The Fed’s mantra was always to take the punch bowl away just as the party gets going. But now we have a Chairman who has altered that thinking and saying “ This party is boring and let’s get some more rum into that punch.”

That means keeping interest rates much lower for much longer at the expense of inflation going up. The 64 million dollar question is will we still get inflation?.

If we do there are consequences for different participants in the markets. Let’s look at them one by one.

This policy change should be very good for consumers. The Fed really wants you to borrow and spend money. So interest rates will remain very low for the foreseeable future for home , auto loans and other types of credit.

This is not good news for long term bond holders. One should be thinking of shortening your maturities in your bond portfolio. Longer term bond holders will get hammered when inflation kicks in and rates rise.

If inflation kicks in prices of real assets should start to rise. That includes equities, gold and other commodities.

This is not good news for retirees who keep much of their money in safer bonds and cash. All of these will return much less than before. The Fed is indirectly forcing them to come out their nests and take more risks. Not a very good idea for old people. Let’s turn to current markets.

Equities

The markets are closed for Labor day observance today, so there won’t be a regular report tomorrow. I may write a special report on the political situation in US.

There are some unique market dynamics that are being displayed. On Thursday the S&P 500 closed down 3.51% . It was only the third time in history the index declined more than 3% for the day, starting directly from an all time high. Two of the most loved stocks of late Tesla and Apple were each down 9% and 8% respectively.

The financial media reports were all about SoftBank, the Japanese conglomerate, had bought about $4 bio worth of FAANG stocks and added fuel to the fire by buying an equal amount of call options on them. Masayoshi Son the main man behind SoftBank has been known for flying too close to the Sun. Son lost about $ 130 mio of his own money after getting into bitcoin around its peak in 2017. Markets have a funny way of humbling you at times.

I think the odds favor that we must have seen a top in the markets. As we outlined in the last report, the S&P closed back below its channel trend line confirming that a throw over is complete. On Friday the NYSE advance/decline ratio started the day with over 4 stocks up for every one stock that was down but ended the day with 1.4 stocks down for every one stock that was up. More than

60% of the shares closed lower for the session in the S&P 500. There could be some relief rally tomorrow but the short term objective for the S&P 500 is in the 3200 area.

Bonds

Believe bonds have resolved its upside correction and is ready to move down. A move down could be very swift and opportunistic. Initial targets are close to 173 and then 170.

Euro

The euro has traced down a five wave structure from its top at 1.2010 on Sep 01 to 1.1780 on Sep 03. Any upside correction should be capped under 1.1875 to 1.1890. The next leg of the down move should target 1.1600 . A break below 1.1780 should give us more confidence.

Gold

Gold is flirting with lower short term channel line supports. Upside should be capped under 1955 to 1970. Only a break below 1870 will open the down side momentum.

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