As we brace for the US CPI inflation data this Friday, traders got hit by another piece of news which made rounds on the tape. Fed GDP tracker is pointing to an annualized gain of just 0.9% for Q2. Down from an estimated 1.3% increase less than a week ago.
Remember Q1 GDP being a negative print? Also recall that a second consecutive lower GDP print for Q2 means recession. With first-quarter growth down 1.5%, a second consecutive quarter of negative growth meets a rule-of-thumb definition for recession.
I know. Too much drama.
The big question going forward is what does the Federal Reserve do? Generally, central banks cut interest rates in a recession to spur the economy. But the Fed is hawkish and just began tightening at the beginning of this month (June 2022). Do they all of a sudden reverse and ease again? Do they then allow inflation to continue to run away?
Here is where things get tricky. I think the markets will be anticipating the Fed having to reverse policy and go back to easy money. Stock markets would like this. Markets will be the best place to go for yield, and if inflation continues to rise, money will still run into stocks because it is the best way to make gains that can beat inflation.
But let’s take the other side of things. This is actually what I believe will happen if the Fed does not actually care about assets. If the goal is to tame inflation, then interest rates must continue to go higher. The Fed also has the opportunity to really put a dent and kill demand. This is an option they have if they want to slow down non-monetary inflation. Get people to not spend money on things. If the Fed goes to an easing policy way too soon, then the inflation will continue to rise. I am betting the Fed will continue to raise rates and even above what people consider the normal range between 2-3%. I won’t divulge the number because it would cause some hardcore anxiety for some. Let’s just say it will hurt a lot of people.
We will have to wait for the data. Many analysts still say the recession will occur in 2023 and not 2022.
“Right now, it looks like any talk of a recession is a 2023 story. It’s not this year,” said Joseph Brusuelas, chief economist at consulting firm RSM. “We would need to see future shocks to the business cycle. My sense is the economy is going to slow, but only really back to its long-term trend growth rate of 1.8%.”
All I know is the Q2 GDP data is going to be highly anticipated. From what I am seeing with rising oil prices and food prices, I do think people are beginning to already cut back on spending. A recession looks likely this year.
When it comes to the stock markets, you all know that as of now, further downside is the path of least resistance. I’m not saying this to be a contrarian. I am saying this because that is what the charts are telling me:
This weekly chart is familiar to regular readers. We have a beautiful head and shoulders pattern. One of the most powerful reversal patterns. A pattern that has not been triggered on the S&P 500 since 2007. And we know what happened then.
4200 on SPX, or 420 on SPY remains the key weekly resistance level. We need a close above this level on a Friday so we have a weekly candle confirmation. Until then, more downside is likely.
Taking it down to the daily chart, some were excited about the bounce at around 3800. Some say this is a bottom. I wouldn’t be too excited just yet. From a structural perspective, things look decent. However, the longer the time frame, the stronger the signal. The weekly chart trumps the daily chart. This is why the daily chart is merely showing a relief rally in the new triggered downtrend on the weekly chart. The daily chart popping and then ranging for two weeks is a clear sign of weakness. If we did bottom, then the momentum should have continued. It is not a bullish sign that we
The big question: Is it time to short stocks again? I think there is an opportunity. Readers know that I await for candle closes to confirm. This would require a daily candle close below this recent range. Or below 4090.
But those with a higher risk tolerance may want to front run this breakdown for a better risk to reward ratio. This is how I would play it:
A short with a stop above the recent highs which tested our 4200 resistance. The risk to reward ratio on this is 1:3.77. Betting $100 to make $377 or more. A small stop loss for some big gains. Proper risk to reward is how you grow your account.
Keep in mind many traders (and algos!) are probably doing this. So if prices do rise above 4200, there could be a big rally as all these stop losses are taken out.