Weekly Stock Market Report: Deflating the Reflation Trade

s&p 500-200mA 2012

Tip: Use this as a quick guide on the short-term direction of key markets. I once had a client that would call me nearly every day asking the direction of the markets. This is a quick cheat sheet to know the trend and help understand what is happening with the markets in the short term.


Key Drivers for the Week of July 12, 2021

TIP – This is a 1-minute brief bullet-point summary. It is a tool that gives investors and financial a fast and simple list of what to watch for and talking points for the week.

  • Reflation trade questioned as various factors slow global growth 
  • Earnings season starts and should move stocks around a bit
  • Production and sales stymied by bottlenecks, hiring difficulties, rising prices
  • Central bank meetings: BoC, BoJ, BoK, RBNZ, all seen keeping rates flat
  • Fed Chair Powell delivers semi-annual Monetary Policy Report Wed, Thurs
  • U.S. data includes CPI, PPI, retail sales, production, consumer sentiment
  • Treasury auctions $120 bln in 3-, 10-, and 30-year maturities
  • BoC expected to keep the policy rate unchanged but should trim QE further
  • BoJ: rate is seen steady but likely to downgrade growth, bump up inflation forecasts
  • Japan economic reports: PPI, core machinery orders, tertiary index, production
  • China releases trade, GDP, retail sales, fixed investment reports
  • Eurozone HICP due, along with readings from Germany, France, Spain, Italy
  • UK calendar has CPI inflation report and labor market data
s&p 500-200mA 2012
s&p 500-200mA 2012

The Dow was up 1.3% to 34,870, with the S&P 500 1.13% firmer to 4369, while the NASDAQ rose 0.98% to 14,701. The dollar firmed up, rebounding after weakening on Friday. The DXY dollar index lifted out of a six-day low and pegged a high at 92.35, which reversed over half of Friday’s decline. The rebound in risk appetite unwound the safe-haven demand for Treasuries yields subsequently surged, mostly wiping out the week’s gains after longer rates plunged Thursday to February lows.

Concession building ahead of the advent of supply also added to the selloff. The long end underperformed with the 10- and 30-year rates cheapening over 6 bps in a bear steepening trade. The Fed’s release of the prepared Monetary Policy Report for Chair Powell’s Humphrey-Hawkins testimony did not break new ground and hence had no impact.

Stocks and bonds reversed course into the weekend, with Wall Street recovering while Treasuries hit the skids. There wasn’t a real catalyst for the move. It seems the worries over the Delta variant and concerns over slippage in growth that weighed on investors were quickly forgotten. Equity bears put the brakes on selling, and the emergence of bottom fishers lifted the major indexes to more to fresh all-time highs.

The reflation trade looks to be deflating slightly as Q3 opens after a massive post-pandemic surge. And signs of the deceleration inactivity, especially in China and the U.S., the engines of global growth so far, have made investors increasingly nervous, with the widening spread of the Delta variant exacerbating worries.

Ironically, some of the slowing has come not from an erosion in spending but from a surge in pent-up demand that is outstripping supply. And, the shortages in material inputs and difficulties in hiring will remain constraints ahead, as will the resulting rise in prices as bottlenecks thin already low inventories.

These factors are likely to keep central banks in uber accommodative mode ahead. Notably, China’s PBoC cut its RRR last week amid concerns over the recovery.


Supply Chain Issues & Christmas Season:  The supply chain issues are likely to continue through the Christmas season. A huge amount of retailers rely on sales during this time to be profitable. If they don’t have the products, they can’t sell. I visited retailers like Best Buy, and the supply is currently very low.

Budget Battle & Infrastructure Bill: Sen. Schumer just sent out a note to Senators that their priority after coming back from the Summer break is to pass a budget and Infrastructure Bill. The Democrats will likely use (or try) “reconciliation” to pass a budget bill that needs to keep the government open and Infrastructure Bill to keep their party supporters happy.  This means that there will not be a “bi-partisan” bill and likely result in the GOP digging in. Senators Joe Manchin and Kyrsten Sinema will be the focus on both sides because the Democrats need both for their “reconciliation.” The Shutdowns have been polled to be damaging to the Republicans in the past, so it is risky if they go there immediately.

200 1D Moving Average: According to BofA’s chief market technician Stephen Suttmeier, the S&P 500 has revisited its 200-day moving average in the second half of the year in 21 out of 35 years in which the S&P did not close below its 200 moving average the first half of the year. This puts it at a 60% chance of dropping. However, the chance is much higher because the S&P only stayed above the 200MA only 13 times (14%) for a calendar year going back to 1929.

Rising Inflation:  Last week, the Dallas Federal Reserve warned that the period of moderate price pressures is coming to a close and that prices of goods could see a significant increase in coming months. Many consumer goods companies are reducing the size of the products while keeping the same prices. June the CPI will be released Tuesday before the testimony. We expect increases of 0.4% for the headline and 0.3% core, following respective May gains of 0.6% and 0.7%. A 3.0% jump in gas prices should boost the headline. Results in line with our projections would leave the 12-month headline slipping marginally to a 4.8% y/y clip from 5.0% y/y, with the core rising to a 3.8% y/y rate versus 3.0% y/y.

The bottom line

I could include several other analysts’ reports, but I think you get the point. A dip is likely to come in the second half of 2021. The increased number of retail investors and use of margin will likely increase the drop fast. Market Bull’s only hope is for a solid Christmas sales season could pull the market up, but they will need products to sell.

Today’s calendar is light. It includes just the Treasury’s $58 bln 3-year and $38 bln 10-year (reopening) auctions. There is also some Fedspeak from Kashkari. Later in the week, much of the focus will be on Fed Chair Powell’s Monetary Policy Report to Congress beginning Wednesday.

The data slate is heavy with CPI, retail sales, production, and confidence numbers. It is also the start of earnings season, with the banks again kicking off the announcements.

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