Stock market participation remains on the low side for a bull market, mainly in Mid and Small Cap Indices. In our opinion, low participation in the S&P 500 Index is not enough to derail the uptrend, but certainly enough to create volatility and uncertainty in the days or weeks to come.
Stocks and indices should be analyzed in different time frames. Our proprietary trend analysis – Greenwich Creek’s Quantitative Trend Analysis – looks at short, mid-term and long term trends to determine the main trend of an index or a stock. As long as the main trend remains bullish, we take pullbacks and corrections within short and mid-term trends as buying opportunities.
In our view, the Thursday selloff was a buying opportunity. Take a look at our quantitative Market Trend table here to see how many “neutral” trend readings we’ve had last week, while the main trends remain bullish and volatility bearish. As a side note, we started working on this table right after the internet bubble (2005) and it served us very well thereafter, allowing us to timely call every bear market, including the mortgage crisis in 2008/2009*.
An important event during the past week has been the flattening of the yield curve. This is when short term yields rise, while long term yields drop. The risk of a flattening yield curve is that it could end up producing an inverted yield curve. Usually, an inverted yield curve is the “waiting room” of an economic recession. A steepening yield curve is just the opposite, an indication of accelerating growth.
Economic data this past week led investors to believe that economic growth might not be as strong as they thought and inflation may be weaker than expected; hence, the flattening of the yield curve. Whether this is right or wrong, in our opinion, the stock market should continue its bull uptrend. Very simply put, we expect this to be the case because in a decelerating inflationary environment, the FED remains dovish (lowering overnight rates). The result is that in this economic environment, stock prices and bond prices move up together.
The other possible scenario is accelerating growth, which made investors nervous a couple of weeks ago. In a growth accelerating environment, the FED becomes hawkish causing the steepening of the yield curve to control inflation. In this scenario, bond prices drop and stock prices increase until the overnight rate, which is controlled by the FED, becomes too high. Keep in mind that the FED clearly stated their willingness to let inflation run above their 2% target to allow for a full economic and employment recovery. The point is that whether yields move down because of concerns of a slowing economy or whether yields move up in expectation of accelerating economic growth, stocks will continue their journey up until the FED becomes too hawkish.
Side note: Regardless of bullish trends in the US stock market, seasonality kicks in soon and selloffs and corrections are always possible. On average, during the last 50 years, August and September are the worst months of the year in terms of performance. If this year is no exception, expect volatility ahead.
(*) The Greenwich Creek Capital Market Trend table is not meant to be used in isolation, it is part of a more complex set of variables and it is not designed to provide trade entry and exit points.
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