ETFOptimize Insights

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Note: Our Research and Analysis articles cannot cover all offsetting aspects of each of our quantitative strategies, nor can they provide the spectrum of aggressive/conservative differences between each model. We track more than 50 different data sets to compose our quantitative indicators. Clients should always follow their model's published systematic decisions to the letter. Doing otherwise negates all the advantages of a quantitative ETFOptimize Premium Strategy, and your results will not track your Premium Strategy's performance. Copyright © 1998–2022, Optimized Investments, Inc., dba ETFOptimize.com. Contact us for reprint permission.

 

 

A Market Based on Hopium
Sunday, August 14

 


 

According to UrbanDictionary.com, "hopium" is the metaphorical substance that causes people to believe in a false hope. Hopium represents the belief that the situation will soon improve.

In this circumstance, very speculative investors have bid up stock prices by about 16% since the June lows. This counter-trend, bear-market rally occurred following a -23% decline in the S&P 500 ETF (SPY) that began on January 3, 2022. The decline was triggered by the US Federal Reserve, now forced to fight the rampant inflation it helped to create in 2020 and 2021 from endless increases to the money supply.

The recent rally since July was 100% caused by speculative investors' hopes that the Fed will soon return to an easy-money, stimulative monetary policy as inflation peaks and slows. This anticipated switch is being dubbed the "Powell Pivot" based on Fed Chairman Jerome Powell's tendency to reverse his decisions on a dime in response to the equity market's ups and downs. In 2022, the Fed has become a psychotic piper leading the minions of market speculators down the rabbit hole into who-knows-where? Probably self-destruction.

You'll discover in this article why I call it a "common, counter-trend, bear-market rally" – rather than claiming a bottom is in and it's blue skies ahead, as is being done by Jim Cramer and the other market cheerleaders on CNBC. (For your own good, if you watch that channel, please turn off that nonsense!)

 

"Inflation Appears to Have Peaked and is Slowing"

This headline was a common phrase heard last week by those who watch market cable TV – i.e., CNBC, Bloomberg, and Fox Business in the US. However, there is very little evidence that inflation has peaked and slowed. Yes, the CPI print for July dropped by -0.6% to 8.5% from 9.1% in June. But one data point does not make a trend.

Chart 1 below shows the current inflation picture given last week's Consumer Price Index (CPI) print for July. Notice that we can barely see the tiny, six-tenths-of-one-percent decline at the far right of this 20-year CPI chart. Keep in mind that at a reading of 8.5%, inflation is still running at its hottest pace in 40 years.

 


Chart 1: The July CPI came in at 8.5%, -0.6% lower than the June print of 9.1%.

 

While the CPI chart above is notoriously glitchy and volatile, we have another inflation chart that cuts out the very volatile food and energy inflation changes. While food and energy are a critical part of any American family's monthly budget, we can get a better picture of less-volatile Core Inflation by pulling out those two components.

Chart 2 below shows the current Core Inflation (Core-CPI) picture with the volatile Food and Energy portions stripped out of last week's CPI print for July. Notice that there was no decline whatsoever in Core Inflation! It rose by 0.3% from June and 5.9% from last year. The difference in the messages sent by each of the two charts (CPI and Core-CPI) came almost exclusively from a pullback in energy prices. However, we know that energy is very volatile, so the assumption that inflation will now trend downward is entirely based on hope (aka, hopium).

 


Chart 2: The July Core-CPI came in at 5.9%, 0.3% higher than the June print of 5.6%.

 

 

Based on a single, small data point in the volatile CPI reading (Chart 1 above), speculators in the market believe that the Fed's interest-rate increases since earlier in the year are having the desired effect. They think we've seen peak inflation, and the Fed will back off rate increases and delay the start of next month's Quantitative Tightening (QT) cycle. However, the Fed's rate increases require about nine months to begin to seep into the economy.

Moreover, the Fed does not want a $9 trillion balance sheet and is determined to reduce it. Powell stated that the Fed would withdraw half a trillion dollars from the economy/markets by the end of the year. This policy will have the opposite effect of Quantitative Easing (QE), which pumped liquidity into financial markets since late 2008 and staged the epic bull rally.

Speculators believe it will be like late March 2020 and beyond; when the Fed was pumping trillions of dollars of liquidity into the financial system, stocks bottomed and rose in a sharp 'V' pattern, and a new bull market resumed for nearly two years. This is the hopium upon which current speculators are placing their bets.

Those speculative types don't understand that the Fed still has a colossal inflation battle on its hands and has no intention of stopping now. The hope that the Fed will pivot and reverse course from tightening to easing in the next month is an asinine fantasy.

ETFOptimize does not offer speculative systematic models. Our primary objective is to avoid high risk and losses, increase Risk-Adjusted Returns, and provide consistently climbing investment strategies.

 

The Technical Picture

Chart 3 below shows a weekly chart of some of the current technical signals on the S&P 500 ETF (SPY). In the top window, I've highlighted the current very strong Resistance level with a Support (green) turning into Resistance (red) in mid-April.

Notice in the top windown that the S&P 500 ETF (SPY) started the week at the 40-week EMA (red line) and climbed to within pennies to the 40-week SMA (green line) at last Friday's close.

 

An Ugly Technical Picture
Chart 3: Resistance held last week, and we could see stocks plummet lower in the coming weeks. RSI and MACD are both bearish.

 

Last week probably saw the top of this bear-market rally, which is why our models remain in defensive assets. Bear-market rallies are well-known for epically powerful selloffs, and it is very treacherous to try to time these rapid ups and downs.

If the multi-faceted resistance level at 430/4300 on the S&P gets pierced, then we'll need to re-assess currently held defensive positions.

Regards,

Christopher Michaels, founder
Optimized Investments, Inc. / ETFOptimize.com

 

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Investor’s all-too-human emotions and subconscious biases relentlessly sabotage their investment results. Trying to follow the news or any other discretionary, judgment-based approach will only exacerbate these underlying challenges, invariably causing investors – whether amateur or professional – to buy after a stock has been rising (high) and sell near the bottom (low), capitulating to avoid losing more. Buying high and selling low attains the opposite result of a classic successful investment approach.

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