The Week Behind

Headline and Core CPI for July both came in below expectations. Headline came in at 8.5%, below the forecast 8.7%, a MoM decline from 9.1%. Core also beat by 0.2%, 5.9% actual versus 6.1% forecast, equal to last month’s report that was also 5.9%. All indices ended the week ~3% in the green: S&P, 3.26%; NASDAQ, 3.08%; DOW, 2.92%.

Highlights

• Headline and Core CPI both beat expectations, which many say “starts the clock” for the string of consecutive declining inflation-prints across economic reports the FED is looking for before willing to ease up on QT.  
• Further verifying the quality of CPI, PPI, a leading indicator for CPI, also came in below expectations: 9.8% actual versus 10.4% projected. 
• Last week’s continuous and initial jobless claims both ticked higher WoW (week-over-week), the first real indication the layoffs and hiring freezes spurred by the FED’s tightening campaign are beginning to read through in the data.
• The NASDAQ officially entered a new bear market, rising 20% trough-to-peak, on a closing-price basis.

The rally needed additional evidence inflation had peaked to keep the party going: CPI and PPI did not leave much to be desired. Adding to the festivities, Thursday’s jobs reports provided the perfect complement for the bull narrative. The slight weakness suggested FED tightening, which has since spurred layoffs and hiring freezes, is beginning to manifest in the data, but only enough for the FED to take notice and not enough to cause a panic surrounding the stability of the consumer. While it is far from enough for the NBER to consider recession or the FED a pivot, it represents another domino that fell in the bulls favor. So long as this domino effect does not grow too strong, it could provide the FED enough heads up to ease appropriately assuming inflation behaves in the next PCE and CPI reports. I want to make it clear that this is a goldilocks scenario: a soft landing. However, a couple weeks ago, this did not even seem like a remote possibility. In other words, the bulls gained a little more credibility this week; so, the markets rallied a little more alongside them. 

The Incremental Buyer

While I predicted upside in the S&P to be 1-2%, I am glad to be wrong and take 3%. However, volume is still light, and for this rally to have staying power, we need volume behind it. Where is that volume going to come from? If it comes, my guess is on hedge funds, corporate buybacks, and quants. 

Hedge Funds

Typically, this group is graded harshly by the quarter. Evident from the resurgence of “meme stock mania” and ~30% WTD performance of heavily shorted stocks, the shorts, which generally tend to be hedge funds, have been squeezed. This implies they’ve been forced into loss via margin calls. As a consequence, it implies they also have money that needs to be reallocated. With timing waning in the quarter, some managers may feel forced to chase this rally to “save” their quarter.

Corporate Buybacks

The buyback blackout period typically covers two weeks leading up to earnings through 48 hours after the report. A lot of quality, high-growth companies – especially in cybersecurity, cloud, and AI – have yet to experience the same recovery as the major indices or mega-cap technology. The c-suites at these companies may be relatively more aggressive in executing their buyback strategy. In summary, as blackout periods end, I expect corporations to become meaningful incremental buyers, which could provide both additional upside and some cushion in the face of pullbacks. Aside, I do not think next year’s inaugural 1% tax on buybacks will catalyze any meaningful increase to buybacks for the remainder of the year.

Quants

Quantitative strategies have specific mandates surrounding certain price levels. The 200d SMA is of particular importance. The S&P500 appears to be on a date with its 200d SMA. Friday, it closed at $4280; 200d SMA was $4328. Some quantitative strategies will sell at the 200d SMA, others will buy it. Given the capitulatory nature of June’s sell-off, leaving me skeptical there are many strategies out there with anything left to sell, and the aggressively positive price action in the market that now poses a legitimate threat to the dominant downtrend, I predict more quants will buy than sell the 200d SMA. 

Given the relatively small volume levels the market experienced last week and the resulting price action, it will not take much in the way of volume to sway price. These incremental buyers represent a lot of volume. Their money, their volume, their say in the market will be important in forming market action for the rest of the month.

The Week Ahead

With respect to economic releases, the week is filled with FED-speakers and Wednesday’s FOMC minutes. On earnings, we hear from the likes of some consumer-centric names – Walmart, Target, Home Depot, BJ’s and Kohl’s – as well as Deere (DE), a big name involved in the agriculture-inflation trade. 

I suspect analysts and IB-firms will release comments on valuation making further upside difficult. Could be a source of weakness to start the week. Otherwise, I do not think there is a high probability of earnings or FED comments surprising the market. The FOMC minutes could cause some commotion, but they are backward-looking. Recent price action suggests the market is more forward-looking than ever. Perhaps, too forward-looking. 

The most important thing to watch this week will be the S&P500 challenging its 200d SMA. A technical breakout would be meaningful in inducing the volume necessary to make recent gains sticky.   

Two Concerns: Price Action in Oil; Balance Sheet Reduction

As I said, I think the market may be too forward looking. While I am no longer concerned by the prospect of lower-than-expected earnings revisions and thus feel the bottoms are in for the year, I do think there are two dynamics in the market that warrant more caution than the price levels suggest are being paid. 

1. Price Action in Oil

Over the last two weeks, oil prices have only responded to demand-factors. Oil moved up the strong jobs number that suggests consumers and companies would consume the commodity at above-recession levels, and on the IEA increasing their demand forecast for the commodity. Prior to these events, OPEC+ announced a non-raise in production, and the price of oil actually slipped slightly. 

Just last month, everyone was obsessed with supply-side in the equation. Furthermore, relief via the SPR could expire in October and additional EU sanctions are set to hit Russian crude come late-November/early-December. If supply comes back into focus with winter approaching, oil could be set for an aggressive move to the upside. 

At ~$95, pre-invasion levels, oil companies now represent a “fair value” hedge against Putin inevitably weaponizing oil and natural gas in the winter. Furthermore, oil stocks could act as a hedge for technology stocks. On Thursday, the NASDAQ’s rally was stunted coincidently with the rise in oil. An indirect correlation could be forming. Not to mention, oil companies also provide a great dividend with increasing FCF and strong balance sheets.

2. Balance Sheet Reduction

In the past, the FED tightened until something broke: hard landing. Balance sheet reduction broke things at the end of 2018. No reason to think it won’t in 2022. While inflation is coming down, no one at the FED would argue an 8-handle on inflation is good. They may not be able to make a dovish pivot as they did in 2018-2019 when inflation was inline with their mandate.