Weekly Market Outlook - Inflation and Bollinger Bands

Things were humming nicely as the unquestioned rally continued on into the latter part of last week. The 0.5% pullback on the last day of last week, however, translated into only a weekly gain of about 0.9% (depending on the index). That said, it’s not clear if last week’s early bullishness and late dip was something we were due anyway, or if it was mostly attributable to Friday’s triple-witching pressures.

If it was the latter, then no big deal. If it was the former though – and if we’re finally ready to pay the toll for such a sizeable runup – then we all need to prepare for a correction that would be considered more than a blip. We’ve got compete thoughts on the issue below.

First though, a recap of last week’s big economic announcements…

Economic Calendar:

Building permits and housing starts were both a little disappointing. Unemployment claims – new as well as ongoing – were essentially in line with expectations. And incredibly, inflation remains muted.

Produce price indices showed mild deflation, coming in at -0.6%; core PPI only saw a modest upswing of 0.1%. Consumer prices were flat, while the core CPI level only saw a 0.10% increase as well. (The numbers are monthly figures… not the annualized rates frequently discussed. Keep reading)

Given the degree of stimulus the economy’s been on the receiving end of (lots of worthless dollars and persistently low interest rates), one would expect to see rampant inflation by now. But, it remains quite tame… perhaps too tame. While excessive inflation stifles growth, a lack of inflation [whether it’s deflation or not] can be an indicator of other underlying problem. It’s too early to ring the alarm bells just yet, but it would be naïve to think we’re going to escape the current interest rate/stimulus scenario without paying a toll somehow, somewhere. For now though, it’s a wait-and-see proposition.

A long-term chart of annualized inflation rates is below with the SPX.

S&P 500 Versus Inflation rate - Monthly

The coming week certainly won’t be as busy as last week was. Tuesday should be a volatile day though, with existing home sales and the FHFA Home Price Index slated for release. New home sales will be announced on Wednesday.

You may recall about a month ago that home prices and home sales were still sinking even though the stock market was rising and the economy was firming. If we don’t see some signs of life now, the bulls better hope for a case where the rising economic tide isn’t required to lift all boats – we’re seeing a major divergence between capital market strength and real estate strength.

Though we’d normally include a VIX chart along with our view of the S&P 500, this week, it’s a bit pointless. With Friday being a triple-witching day (where monthly as well as quarterly options and futures expire), the VIX was most likely skewed. That can be bullish or bearish, depending on the situation. More importantly, it can make for misleading reads on the indicator. We’ll resume our looks at the CBOE Volatility Index next week after it’s settled back into its normal groove.

In fact, there’s surprisingly little to talk about regarding the SPX, save the fact that we all quietly know the index is overbought, and we know it’s only a matter of time before we have to pay the toll for the 9.8% gain we’ve enjoyed over the last five weeks.

That time may be now, if the 50-day Bollinger bands are any indication. Though the 20-day Bollinger bands are generally useful, the 50-day band lines have been a little more meaningful as slowing/reversal levels for the bull market thus far. That’s pretty evident on the chart below.

Moreover, you can see the S&P 500 just encountered the upper band this week; the bulls’ bluff is being called…. if it’s actually a bluff.

SPX Daily Chart

At this point it’s premature to call for an outright pullback, though it’s not too soon to start assuming the rally is at least going to start being capped now. Being as vulnerable as we are to a selloff though, it would take very little for the bears to get their ball rolling again. One decidedly bearish day could be all that’s needed to send the SPX back down to the lower band line again. It’s currently at 1055, which is also pretty much where the 200-day moving average line is.

Sector Performance:

A big reversal of roles last week put the market’s formerly biggest loser at the top of the heap… telecom. In fact, telecom is now also the two-week leader – proof you can never get too comfortable with the status quo of relative leadership. In any case, it’s a group that’s now worth exploring for breakout candidates.

On the flipside, energy and basic materials were found at the bottom of the barrel for the week, and are actually the only two sectors in the red for the past two weeks. Ditto to what we said about the status quo above…. basic materials have been leading the race for the last year, and are vulnerable to profit taking. With that in mind, last week is nothing to dismiss.

Trade Well,
Price Headley
BigTrends.com
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