A New Week 09/20

Since 1988, the S&P 500 has declined by ~4% on average after the Fed begins a tightening cycle.

All of which happens in a two to four-month period.

This would make it seem like a near guarantee of a decline in the market now that the Fed hiked rates by 25bps last week.

But,

Goldman being Goldman, they chose the very specific “tightening cycles” language in this chart, meaning two or more rate hikes with accompanying monetary action from the Fed.

In other words, the market could very well continue to go higher from here despite last week’s hike, especially if participants don’t think the 25bps move was enough.

Judging by the 10-year Treasury’s close back above 5% on Friday, I would be of the opinion that the market doesn’t think the hike was enough.

Which means higher we go, and a longer oil/diesel crisis mode waits ahead as well.

That’s fine, it’ll give me more time to structure the best long/short portfolio possible around a normalizing diesel cost wedge.

Click here to see how markets already bet on that normalization by the midterm elections.

Now let’s get an update on what the market likes and dislikes:

Momentum, growth, and the dollar.

Those were the only factors that gained over the week despite a ~0.4% decline in the market overall.

This is the result of all the daily auctions covered in the morning digests, as the 25bps hike reaction was covered as net bullish for the AI trade, especially considering markets didn’t see the hike as aggressive or “enough.”

If that is the line of thinking, then of course the financing and credit capacity to expand on the AI buildout will take place with much less obstruction, pushing growth and momentum names higher as a result.

Spreads like these also tell you that concentration in the market is also increasing, as breadth and size (mid-caps) underperformed the most during the same week.

In other words,

The passive hike ended up hurting a lot of the real economy and its prospects, while giving the AI trade another leg to run on.

If this eventually becomes a problem, then I would think yields go much higher than 5%, with a sensible target being 6.8% or so given the latest news out of Japan.

Click here to read how rising Japanese yields force a more competitive U.S. Treasury yield.

My usual read on the commitment of traders (COT) report has been extremely quiet as of late…

So I decided to create a new gauge and begin covering it until the futures market provides a reliable signal once again.

This measure represents the spread between daily VIX implied moves versus S&P 500 daily realized moves through time.

As you can see, each time we reach a 1-2 standard deviation, it creates a fantastic dip buying event, especially if you start playing options portfolios.

Right now, things are quiet and supportive of a continued breakout in the S&P especially now that we’ve reclaimed $7,700.

However,

This also means volatility spikes could show up unannounced.

Note: Whenever this spread widens, it means current market conditions and assumptions have changed enough to correct the options market, and consequently the VIX (which is priced upon these option expectations.)

No such expectation corrections coming about.

Now let’s cover some items for this coming week:

New Earnings:

Lots of gauges on the consumer this week, and even one AI wild card.

KB Home (KBH), Costco (COST), and Darden Restaurants (DRI) all report this week, giving us a direct view on what the consumer trends are in the U.S. as well as where some of the weak points remain in this coiled spring.

Even more interesting, especially as it pertains to my OPENLANE (OPLN) thesis, we’ll get the latest from AutoZone (AZO) this week as well.

BlackBerry (BB) is also lined up for the AI trade as it has recently become involved in the technology’s buildout and development.

Of all these, I am most interested in Costco, so I will likely end up covering its earnings in-depth this week.

Durable Goods Orders - Friday:

The only economic report this week that could command the market’s attention.

Durable goods orders will give us a further look into the state of business expenditures, expectations, and how the future outlook stands for the average business activity.

According to recent PMI data and respondents, most executives are worried about increased lead-times and supply disruptions out of the Middle East, which is keeping their order flow out of whack.

Therefore, I too find this report a potential market-moving event to close the week.

Surprisingly, even after Goldman ‘s research posted the high-probability of a market decline after the recent rate hike, they are now calling this the clearest bullish setup in a while.

You can listen to this with the filter I mentioned above, that the declines in the S&P only happen after two or more hikes take place:

Until next time,

OFFSIDE RESEARCH

Against the Tape, Ahead of the Curve.