Earnings, Stalling Economy Warns Against Complacency
Tensions are high heading into the start of the Biden administration and the first full week of earnings. However, compared to the frequent Tweet-induced market declines over the past four years, the market has been fairly stable since President Trump was banned from Twitter.
Speaking of tweet-induced market panics, despite repeated claims of how the U.S. has had extensive gains in the trade war with China, the data does not tell the same story. This was the focus of Bloomberg’s article last week, “How China Won Trump’s Trade War and Got Americans to Foot the Bill”. In data up through November, the U.S. trade deficit with China for 2020 was $287 billion, above the “$254 billion gap in 2016”.That is more than a 10% increase in the U.S. trade deficit.
On the home front, last week, we got the latest reports on the Consumer Price Index (CPI) and Producer Price Index (PPI). The CPI recorded a 0.4% gain last month, the highest reading since August, but the inflation rate was still low at 1.4%. This modest increase was attributed to recent increases in gas prices.
However, the data from the U.S. Bureau Of Labor Statistics gives a somewhat different picture of what has happened, focusing on food prices in the past year. The downtrend from the 2012 highs (line a) was broken in 2019. Inflation rates for food have been in a solid uptrend since early 2020 (line b), and the latest data shows that food prices have increased 3.9% over the last twelve months.
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Those who rely on a monthly food budget to get by have certainly been forced to make changes to their shopping habits, further complicated by safety concerns during surges in COVID-19 cases throughout the year. Many financial writers do not seem concerned that inflation will increase, but even those who are have not been discussing food prices.
Esther George, the President of the Kansas City Federal Reserve, commented last week that inflation could rise more than some expect if the vaccine-spurred economic rebound is stronger than expected. George is known to be one of the more hawkish Fed Presidents on matters concerning inflation. Though she did not suggest any imminent change in the Fed’s accommodative policy, she did acknowledge the recent surge in some prices.
My first reaction to the chart of food prices was to examine the price charts of some key agriculture commodities. Corn futures have risen from around $3.10 per bushel in April to a high of $5.41 last week. Prices have surged above the resistance (line a), but given the 2012 high near $8.50 (not shown), there is room for further gains. Wheat, another key grain, had prices as low as $4.71 per bushel in May 2020, and last week hit a high of $6.93. Some of the change in food prices is a result of the higher grain prices.
The problems with the CPI have been discussed for years, as its “basket of goods” methodology does not measure the impact of substitutions as consumers switch to less expensive items. Some studies have suggested that in recent years, the CPI actually understates inflation “by 0.3 to 0.9 percentage points.”
The increased discussion over inflation has been spurred by the recent surge in interest rates. Of course, with rates at historic lows, the real interest rates, calculated by subtracting the inflation rate from the yield, are actually negative. The 10-Year Treasury Inflation-Indexed Security chart from the St. Louis Federal Reserve shows that the real inflation rate turned negative in early 2020 (point a).
The very low rates and the Federal Reserve’s stated policy of keeping rates low as long as inflation stays low has added to the bullishness and complacency of many investors. Comments from Fed Chair Powell indicate that the Fed is not even contemplating the conditions under which the FOMC would plan to increase rates or reduce bond purchases.
In this environment, it was not surprising that the big banks that were scheduled to report earnings before Friday’s open were sharply higher on Thursday. The prevailing opinion that stocks can only go higher, rather than the fear of an earnings-based decline, seemed to dominate the price action.
Based on this, Friday’s 7.8% decline in Wells Fargo & Co. (WFC) on double the average volume must have caught some by surprise. Citigroup’s 7% decline to close at $64.23 after Thursday’s high of $69.43 was not a happy way for stockholders to start the long weekend. Both stocks had traded above their daily starc+ bands before Friday’s decline. One of the key questions in the weeks ahead is whether the earnings reports will justify the current stock prices.
As for the wider market, was another week where the iShares Russell 2000 (IWM) led the averages with a 1.5% gain while the Dow Jones Transportation Average and Dow Jones Utility Average managed smaller gains. The Nasdaq 100 Index was the weakest, losing 2.3%, followed by a 1.5% decline in the S&P 500.
With the decline in the Nasdaq 100 Index, the Invesco QQQ Trust (QQQ) looks as though it could still decline further. Last week, the large tech leaders like FB were down over 6%, and there were solid losses in many of last year’s leaders.
A decline in the QQQ below support at $309.49 (line a) could trigger a drop to the January 4 low of $305.18. The 38.2% Fibonacci support from the November 2 low is at $299.37, with the 1st Quarter pivot at $298.46. The daily Nasdaq 100 A/D line closed Friday below its weighted moving average (WMA), but is well above the long-term support (line b). The daily Moving Average Convergence-Divergence (MACD) lines peaked in early December and have continued to form lower highs (line c). The weekly MACD lines (not shown) are still positive.
The options activity also still reflects a too-bullish environment. On Friday, there were over twice as many call options traded as there were put options. The equity put/call ratio closed at 0.45. This is another sign that too many investors and traders are complacent, thinking stocks can only go up.
The bullishness of investors and traders is also tied to the consensus view that the economy will be rebounding sharply later in the year, which in turn will be a positive for companies’ earnings. Hopefully, that will indeed be the case, but it is my experience the consensus views often turn out to be wrong, and so this kind of consensus is cause for concern.
Even though I feel it is likely that stock prices will be significantly higher in the next year, they could also be significantly lower in the interim. Popular ETFs, like the Ark Genomic Revolution ETF (ARKG), were up over 180% in 2020. This ETF made a new high on Friday before closing the day lower at $107.96. ARKG has been trading above the weekly starc+ band for six of the past seven weeks.
The 20-day exponential moving average (EMA) is about 7% lower, at $100.30 with stronger support in the $90 area. The longer-term uptrend (line b) is now at $79.78. The relative performance (RS) versus the S&P 500 did not make a new high last week (line c), which may indicate a loss of upside momentum.
The volume has tended to be higher on days when ARKG declined, so the On Balance Volume (OBV) has been diverging from prices (line d), and has just rebounded back to resistance (line e). One wonders if those who recently bought ARKG at $105 or higher will stay with their positions if it should drop back to the $85-90 area, which is where I would be looking to get back in.
Based on similar activity across the market, investors and traders should be focusing on the risk before establishing new positions. Until there is a significant market decline that reduces the overall market risk, I am wary of establishing too many new long positions.
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