Edition #12 - 6.1.2021
PCE Inflation Has Arrived, NAAIM Exposure Index, & Evaluating the S&P 500 and Russell 2000
Economy:
Arguably the most important economic news from all of last week was released on Friday’s session, highlighting the continued momentum & increase in inflation. The report specifically covered personal consumption expenditure (PCE), which I have highlighted in prior posts regarding the inflation metrics being monitored by the Federal Reserve. For the month of April 2021, the year-over-year percent change in the PCE was +3.6%, the highest YoY change since September 2008.
Since the Great Recession, the PCE has hardly increased by more than +2.5% for any given month, so this is clearly a significant increase. This is also one of the quickest accelerations of the PCE, behaving very similar to the period immediately after the 2008 - 2009 recession ended. We can notice that while the PCE rapidly accelerated from July 2009 to January 2010, the measure began to stabilize through November 2014 (fluctuating between +1.1% and +3%). During that period, the average monthly YoY PCE change was +1.83%. The Fed has indicated that they are targeting an average inflation rate of +2%, and that the pre-pandemic trend of inflation being less than +2% is prompting them to achieve a rate of inflation “moderately above” +2% for some time.
Therefore, while I expect the PCE rate to stabilize in the near future, I would not be surprised to see a continuation of this recent acceleration first, followed by a period of stabilization.
Stock Market:
Last Wednesday, in Edition #8, I covered the NAAIM Exposure Index. At the time, active manager respondents indicated a 68% allocation to the S&P 500 vs. 44% from the prior week. This 24 percentage increase is quite substantial, but is still well-below what would be considered “euphoric” or “overcrowded”. To me, this implies that there is still a healthy amount of hesitation and aversion in the equity market, keeping investors honest with a healthy amount of risk. I think the NAAIM Exposure Index continues to reflect bull market behavior, particularly at the beginning stages of a bull market.
With that said, I wanted to provide some insights on what I’m seeing at the index level from the S&P 500 and the Russell 2000 in terms of price structure & technical analysis. Each chart has the 21, 55, and 200-day exponential moving averages (EMA’s) with a Williams%R oscillator on the lower-bound. The EMA’s are used for several reasons, but I use these three as dynamic support/resistance levels. Often times, price will dramatically exceed the EMA’s, indicating that momentum is very high & the asset is over-extended. This extension period always ends at some point, in which price falls & can occasionally retest the EMA’s before continuing to rally higher. I also use the EMA’s as a way to objectively define a trend. When price > the 21 EMA (yellow), and the 21 EMA > the 55 EMA (teal), that indicates that the asset is in a strong uptrend. If/when the 21 EMA crosses beneath the 55 EMA, momentum has shifted to the downside. We’ll see this in practice shortly.
The W%R oscillator shows an assets price relative to the closing price over the last x periods. When the oscillator falls beneath the lower-bound, it indicates that the asset is “oversold” relative to its price history. Conversely, a reading above the upper-bound indicates that the asset is “overbought”. For me personally, I use an oscillator with a length of 20 days, which lets me evaluate the current price of each index relative to the movement over the last 4 trading weeks.
S&P 500 (01/01/2020 - Present):
First of all, the rising wedge that I’ve been highlighting since March 9, 2021 continues to act as both support & resistance at the lower & upper-bounds. When we look at the indicators on the chart, we can see that the 55 day EMA (teal) has acted as support multiple times since the COVID lows. Even when price did not immediately rebound on this level, it still provided an excellent buying opportunity during pullbacks. We’ll notice that the S&P 500 retested the 55 day EMA two times during the month of May, immediately rebounding on that level.
As I mentioned above, the relationship between the 21 day EMA and 55 EMA is a key indicator for me. Going back to Q1 2020, we can see how the 21 EMA crossed below the 55 EMA, which occurred on March 3, 2020. After this point, the S&P 500 proceeded to fall an additional -28% over the subsequent 14 trading days. This was a strong bearish signal, indicating more downside. After the disastrous decline in the index, the S&P began to rally but didn’t fully give a “bull” signal until the 21 EMA crossed above the 55 EMA on May 18, 2020. Over the subsequent 3 months, the S&P gained +15% & has continued to rise tremendously ever since.
You’ll notice that the 21 EMA has yet to cross beneath the 55 EMA since the bearish signal on 3/3/2020, continuing to imply strong upside momentum in a bull market. I will continue to remain bullish on short-term price action so long as the 21 day EMA remains above the 55 day EMA. Additionally, I would begin to de-risk in the event that price breaks down beneath the lower-bound of the wedge & fails to catch support on the 55 day EMA. However, that is simply my risk management strategy as a trader, not as someone with a long-term retirement account or portfolio constructed with a 3, 5, or 10-year horizon.
In regards to the W%R indicator, we can see that the oscillator is finalizing an extension from being oversold to overbought. These types of momentum thrusts are usually strong signs of momentum (see the shaded grey regions following an oversold to overbought extension). With the oscillator finally back at the upper-bound, I see this as a good momentum signal, especially after a recent retest of the 55 day EMA. It might even be possible that the S&P 500 is able to break out of the rising wedge as we begin to approach Q3.
Russell 2000 (01/01/2020 - Present):
Similar to the S&P 500, the Russell 2000 should move closely in accordance to the price action we saw in the above chart. However, the Russell is much more indicative of how small cap companies are performing. Despite an extremely strong & fast start to the year, in which the index gained +17% through 2/10/2021, the index has been in a sideways consolidation since that date. Regardless, the index is currently +14.9% YTD and leads the Dow, S&P 500, and Nasdaq for YTD performance.
We can visualize the sideways consolidation with the upper and lower-bound of the grey regions, as well as the white wedge that has formed, for our outlines of support & resistance. The first thing we should notice is that the price of the index is currently retesting the upper-bound of the white wedge. The slope of this trend line has acted as resistance at the YTD highs on 3/15/2021 & then again on 4/29/2021. The index proceeded to fall by -11% and -8% after each of those instances. I do not know if price will get rejected from this level for a third time, or if we’ll see a breakout, but this simply implies that we’re headed into an important week for small caps.
The 21 day EMA (yellow) is still trading above the 55 EMA, which gives me a bullish bias for the intermediate term; however, I’d be willing to rotate to a short-term bearish view if/when the price of the index falls below the 21 day EMA. At the present moment, that would simply take a -1.7% decline from Friday’s close in order to potentially imply some bearish momentum, potentially back to the lower-bound of the white wedge at $2,145. At the end of the day, that’s a minimal correction of -5.5% so this isn’t a “sky is falling” prediction. Far from it in fact. Normal & healthy bull markets have short-term corrections and consolidations. I’d actually be more worried if the market wasn’t exhibiting corrective behavior and was continuing to ascend without interruption.
I don’t have any crypto-related news, charts or data that I’d like to share so that’s a wrap for today’s newsletter.
Until tomorrow,
Caleb Franzen