Flow State #41
Weekly Outlook
Welcome back, everyone!
This week we will kick off this newsletter with a recap of last week, then move on to the following sections: Market Sentiment (COT Report), Sector Performance, Weekly Outlook (ES & NQ), Momentum Gallery (Stocks), Events, Earnings, Market Structure (ES, NQ, CL, GC, NG, DXY), Daily Plan 8.28.23.
Previous Week Recap
Key Points of Powell's Jackson Hole Speech:
The Federal Reserve is committed to bringing inflation down to the 2 percent target.
There has been significant policy tightening over the past year to address inflation.
Even though inflation has reduced from its peak, it's still high. The Fed is ready to increase rates further if necessary and will maintain a restrictive stance until confident about inflation decline.
He highlights the progress so far and the future outlook considering the uncertainties of the Fed's dual mandate goals.
Inflation's surge began due to the interplay of strong demand with a supply chain constrained by the pandemic. The Federal Open Market Committee responded by raising the policy rate in March 2022.
U.S. headline inflation was at 7 percent in June 2022 and dropped to 3.3 percent by July. The Russia-Ukraine conflict played a role in these fluctuations.
Core PCE inflation (excluding food and energy) peaked at 5.4 percent in February 2022 and decreased to 4.3 percent in July.
Despite the drop, two months of favorable data aren't enough to ensure sustained inflation decline. There's still a way to go before achieving price stability.
He breaks down factors impacting core PCE inflation into goods, housing services, and nonhousing services.
Core goods inflation, especially for durable goods like vehicles, has seen a sharp decrease. This decline is attributed to factors like increased production, better supply, and the effect of higher interest rates on demand.
The housing sector saw rapid shifts after policy changes, with mortgage rates doubling in 2022, decreasing housing activities, and market rents declining. Housing services inflation is expected to adjust as market rent dynamics evolve.
Nonhousing services, a significant portion of the core PCE index, show stable yearly inflation but declining short-term rates. The sector's unique challenges mean tight monetary policy is essential for price stability.
Outlook:
Despite the unwinding of pandemic-related distortions aiding in reducing inflation, a restrictive monetary policy will become increasingly crucial.
Achieving a consistent 2% inflation will necessitate a period of slower economic growth and some relaxation in labor market conditions.
Economic Growth:
Restrictive monetary policy has led to tighter financial conditions, resulting in expected slowed growth.
Real yields have increased significantly since last year's symposium. Tighter financial conditions typically lead to slower economic activity growth.
There are indications of the economy not cooling as anticipated, with GDP growth surpassing expectations and consumer spending being robust.
An overly positive growth trend could require further tightening of the monetary policy to manage inflation risks.
Labor Market:
The labor market continues to recalibrate, with improvements in labor supply due to increased participation among 25 to 54-year-olds and immigration nearing pre-pandemic levels.
Demand for labor has reduced slightly, as seen with the decrease in job openings and the slowdown in payroll job growth.
Wage pressures have been alleviated, with a gradual slowdown in wage growth. The focus is on real wage growth, which has improved as inflation declined.
Should labor market tightness persist, it might necessitate a monetary policy adjustment.
Uncertainty and Risk Management:
The inflation target is set at 2%. The goal is to implement a monetary policy that restricts inflation to this level over time.
Identifying the neutral rate of interest in real-time is challenging, leading to uncertainties about the exact monetary policy restraint needed.
Monetary policy decisions are further complicated due to uncertainties in how quickly such decisions impact the economy and inflation.
There have been deviations from historical economic patterns, such as job openings dropping without increasing unemployment, suggesting a high demand for labor. Inflation also seems more sensitive to labor market conditions than before.
Balancing the risks of over-tightening and under-tightening monetary policy is essential. Overdoing can harm the economy, while underdoing might embed higher inflation levels.
Conclusion:
Policy decisions are being made in uncertain times, emphasizing the importance of risk management.
Future meetings will evaluate progress using comprehensive data, risks, and evolving scenarios to determine whether to further tighten monetary policy or maintain the status quo.
Achieving price stability is paramount to fulfill the dual mandate and ensure a robust labor market benefiting everyone.
NVDA experienced a surge post-earnings, reaching my target of 500, a crucial point at which I intended to short. Specifically, I had highlighted the 21 June 2024 LEAP Puts. Subsequently, the stock has dropped by 50 points in two sessions, settling in the 450s.
LLY consistently rises, registering new highs. As anticipated, I expected this stock to maintain its strength after I predicted its surge beyond 500 post-earnings. Any of the forthcoming days might witness a significant upward movement, thereby increasing volatility.
I had pinpointed META and TSLA as other stocks to short. META declined by over 25 points from 300, whereas TSLA hasn't plummeted despite the pronounced rebound observed on Friday. These stocks are mirroring NVDA's trend, utilizing long-term option contracts, granting ample time for a downward movement. It's rare for me to adopt a bearish stance on these companies when they're at their peak. However, as we conclude this robust earnings period and as market conditions appear to deteriorate, I'll consider shorting before turning bullish again. Stocks like LLY and AVGO, for instance, haven't made me bearish yet, as they consistently achieve new highs weekly.
The indices have consistently presented us with dynamic sessions. A notable example was last Friday when we didn't close on a lower note, but there was a marked plunge after I advised that long-term investors should exercise caution. In fact, this advisory was issued when NQ was at its peak, prompting a drop of over 300 points. ES remained steady, leading me to shift my focus to NQ, whose performance aligned seamlessly with my projections. Lately, ES has presented fewer opportunities compared to NQ. Hence, until this dynamic changes, my primary emphasis will be on tech, represented by NQ.
Oil touched a new low before bouncing back above 80. However, many were caught off-guard by my Heating Oil prediction last week. It witnessed minimal to no selling before ascending to a new peak, marking an impressive forecast within the energy sector.
A noteworthy indicator last Friday hinting at a potential reversal was the intense selling observed in Gold. As indices started to recover, Gold lingered at its lowest, unable to rally. During event-driven sessions, particularly when long-term investors are making crucial decisions, Gold tends to diverge from the indices, a pattern not observed in recent weeks.
As we transition to our plans for the upcoming week, it's evident that positions are evolving, and it would be unwise to overlook these unfolding scenarios.