Two weeks ago, I put out an article stating that the US stock markets may have developed a bottom. That call has worked well for our readers. The call was driven primarily by what I was seeing on the technicals. Once again, technicals and charts are very important as they display market psychology and sentiment.
In that article, I outlined the major levels that I would need to see break in order to turn into a full on perma bull. These levels on the various US market indices are being tested now. And so far, we are seeing signs of struggle as expected.
There are many reasons why the markets could falter here. In simple technical terms, the breakdown below these zones months ago is what triggered this downtrend in stock markets. As long as price remains below these levels, the downtrend is still intact and this move higher has just been a brief pullback or relief rally. Once again, all of this is nullified if we get a weekly close above these zones. Then we go long everything.
The fundamentals are where things get interesting and requires more thinking… or some may say speculation.
Most of the market participants believe that the Federal Reserve is getting ready to pivot and start cutting interest rates due to a recession. However, it appears that the definition of recession has been redefined. One plus one does not always equal two.
The markets are acting as if the Fed is pivoting, but that has not been confirmed just yet. There is a real possibility that markets could get a wake up call when Powell comes out even more hawkish and proclaims the Fed will continue to raise rates to tame inflation and because there is no recession. He will probably repeat the fact that the labor market looks strong and indicates no recession.
Why am I saying the market seems to be pricing in a pivot? For this, we need to look at the bond market:
We have recently seen the US 10 year yield confirm a reversal pattern known as the head and shoulders with a break below 2.70%.
Just a reminder, there is an inverse correlation between bond yields and bond prices. So when bond prices are going up (people are buying bonds), yields drop and vice versa.
With this breakdown in yields, it means bonds are being bought. The thinking is that this is due to investors pricing in a reversal in interest rates. If the Fed is going to begin cutting rates due to a recession, it is better to buy bonds yielding this much because future bonds will yield less thus making current bonds valuable.
But what if this has nothing to do with the Fed? What if instead, investors are buying bonds as a sign of fear? When we have a risk off environment, money tends to leave the stock market and head for the safety of bonds and the US Dollar. We aren’t seeing signs of that quite right now, but this is something I would watch for in upcoming days.
Are there any events upcoming which could drive some fear and potentially be black swan events? You bet.
As I am writing this, House Speaker Nancy Pelosi has landed in Taiwan becoming the highest US official to visit the country in 25 years. Investors are beginning to weigh in China tensions, and many of us hold our breaths as we await China’s move. The CCP has even threatened military action. Whatever happens, we can all agree that the world looks more splintered and that uncertainty of the future will keep weighing on investors’ minds.
Kosovo could be another hot spot. Tensions arose when Kosovo announced measures against Serbians including extra documents and license plate rules. It even said that NATO forces and peacekeepers were on standby. As of now, things have calmed down as Kosovo postpones the new rules.
What will I be watching this week? I will be keeping an eye on those stock market levels and watching to see if we can confirm a weekly close above our major levels by the end of this week.
Happy trading.