Inflation seems to be the main focus of Wall Street right now. Some say it's temporary. Some say we will see hyper-inflation, but whatever it is - the question is, what will it do to stock prices? I'm not an economist so this is just a layman's interpretation, and that is, if prices are going up because of a weakening dollar, stock prices can also go up. That is until the backend prices go up enough to put pressure on business costs, and then earnings can suffer, and of course stocks prices are directly correlated to corporate earnings.
The stock charts are looking strong, but they are also near their recent highs and that is always a test. Can they continue higher, or will we see some profit taking? The reason we often see double top pullbacks is because prices are returning to where they were at the prior high, in the case of the S&P 500 - the early September highs, and many traders and investors look at it as an opportunity to sell where they wish they sold before the pullback started. So that's the mentality right now going into this week.
But we also have investors who missed the rally as we head into the strongest part of the year for stocks, so pullbacks could be shallow as the dips get bought by those who think they are underinvested.
One thing to note is the open gaps on the chart. Normally it is very rare to see open gaps on the S&P 500 chart for any duration. Once in a while you see a breakaway gap like the lower one on October 14th that stays open for a long time - we have one still open from April 2nd - but to see four right in a row like that stay open for any length of time would be very extraordinary, and unlikely. But as the market often does, it could do the opposite of what we all expect.
Yields were up early on Friday but they reversed after hitting the top of that F-flag formation, and pulled back down. It's a little ironic that the Nasdaq, which seems most negatively sensitive to rising yields, was up on Thursday when yields were up, and down on Friday when yields were down. Something to keep an eye on, although I assume this week's big tech earnings reports will play more of a role than yields.
The dollar was down sharply helping all of the usual suspects, including the I-fund. Despite the breakdown below some rising support lines recently, you can see that last weeks low was holding at the bottom of the September open gap, and above the 50-day moving average. 25.10 looks to be a key level. Inflation hawks are likely looking for the dollar to bust below all of that support before long. As we said above, that could give stocks a price advantage for a while, unless companies start to report how rising costs are impacting their bottom line. Then it becomes a hindrance.
Lots of earnings this week, and the FAANG / MAGA stocks will be in the spotlight. Also, with the recent dramatic decline in economic growth projections for the 3rd quarter, economic data reports will also be magnified this week. We get the Consumer Confidence report on Tuesday, as well as new home sales, retail and oil inventory numbers on Wednesday, GDP and weekly jobs numbers on Thursday, and personal income and spending data on Friday.
The S&P 500 (C-fund) was flirting with the September highs late last week as the relentless rally off the lows continues. Clearly this is stretched to the upside and at least some consolidation, if not an outright pullback, is due. there's four open gaps below and a bearish rising wedge was broken late last week, but we know that steep angle of incline couldn't last forever. The question is how much backing and filling can this do before the dip buyers jump right back in?
The DWCPF (S-fund) is also rising at an angle that would be tough to sustain for very much longer, but that doesn't mean it has to come straight down. That's what those on the sidelines are hoping for to give them a chance to get in on the bullish wave, but the market doesn't often give easy opportunities. The open gap near the 50-day EMA sounds like perfect spot for them, but will it be that easy?
The EFA (EAFE Index / I-fund) is another piece of Swiss cheese with open gaps all over the chart. Resistance is apparent at Friday's high near 80.50 and that usually means one of two things: Another gap up above all of the resistance, or a pullback to start filling in some of those open gaps. If the dollar continues to fall, it may be prudent to get some I-fund in your account if you are choosing to be in the market.
The Japanese Nikkei Average peaked last week at the June high, possibly filling out the right shoulder of a head and shoulders pattern. Friday's action saw a drop that filled in an open gap, but it did rebound once it tested the bottom of the gap. That's the good news - if there is any. The bad news is it closed below the 50-day EMA for a second straight day, after four days of being above it, so it could be a failed breakout. Japan's market makes up about 25% of the I-fund.
The BND (bonds / F-fund) got a bounce off the recent lows, which actually goes back to a reversal back in June. It is now solidly below the 200-day EMA so unless you are predicting a bottom (even if temporary) for bonds, the chart is in bad shape going forward unless or until it can get back above descending resistance and that 200-day EMA.
The Dow Transportation Index spent most of the spring and summer lagging the S&P 500 but something triggered a switch in October and it has been exploding all month. Perhaps the prior weakness was investors playing the collapse of the GDP in the third quarter, and now they are expecting the economy to improve in the 4th quarter? That's speculation, but clearly something has changed.