What To Make Of The Numbers, The Fed, And What’s Next…
Last week, I ended my usual market commentary on a mixed note…
“I am optimistic we will see a rally near the end of the month. But that rally is likely to begin from a sharply lower price level.”
In other words, my analysis was telling me that we were likely to see a decline in the stock market before a rally at the end of the month. Since then, the S&P 500 has followed my prediction, dropping 2.9%. Now, the question is whether we will see that rally at all.
The answer could lie in two concerns that aren’t directly related to the stock market.
Traders are concerned about COVID-19 again — as they should be. Perhaps they should have never stopped never being concerned about the pandemic.
The chart below shows there has been an increase in the number of cases in the United States. This chart uses a seven-day moving average of reported cases to smooth the data and allows us to see the trend. Right now, there is no doubt the trend is up.
Source: The New York Times
That chart is concerning. But another chart shows there is some potential good news. The number of deaths is in a downtrend and that trend didn’t reverse in the past few weeks.
Source: The New York Times
No question, there is a lot to worry about in this data. But the diverging trends show that there is likely to be a divergence in opinions. Some will see the rise in cases as alarming. Others will point to the decline in deaths with hope that the virus is weakening or treatment is improving. Everyone is likely to point to their favorite data and hold fast to the opinion.
Just like everyone else, traders will also have a strong opinion about the pandemic and how it will affect the economy. This will lead to volatility in the stock market.
A second concern for traders is the upcoming presidential election. This will also affect volatility and will be less predictable in some ways than other elections. The epidemic is affecting the economy, and the economic environment generally impacts voters. The virus will also affect campaigning, and experts will have trouble interpreting the data as we move toward November.
Actually, many votes will already be cast by November because mail-in balloting is expected to increase this year. That’s another factor contributing to uncertainty and volatility in the stock market.
The One You Should Really Worry About
These are all factors I will watch in the coming months. But these factors, as important as they are, might be overwhelmed by the experiment the Federal Reserve is conducting, shown in the chart below.
Source: Federal Reserve
This is a chart of the year-over-year change in M1, basically the amount of currency in circulation. It’s the narrowest measure on money supply, and the Fed’s actions are driving larger changes in the other factors. I used this chart because it provides the longest history. The trend is the same in all components of money supply.
All that money the Fed is creating has to go somewhere. In the 1970s and 1980s, Fed policies contributed to a rise in inflation. Since 2009, that money has contributed to the bull market.
Money supply is now an important indicator to watch. At some point, the Fed will probably need to take some money out of the economy to reduce the risk of inflation. That could crash stocks. So that is another important story to watch.
In The Meantime…
These are all longer-term factors that should drive stocks in the months ahead. In the short term, there is a strong seasonal trend associated with the Fourth of July holiday. Generally, stocks tend to rally around that holiday. That trend can be seen in the next chart.
By themselves, I don’t believe seasonal trends ever provide enough information to make trading decisions. But they can provide input along with other factors. The next chart shows that this pullback may have been deep enough to attract buyers.
This chart shows Invesco QQQ Trust (NASDAQ: QQQ). This is an ETF that tracks the NASDAQ 100, an index that includes market leaders like Apple and Tesla. At the bottom of the chart, it shows the distance between the close and the five-day moving average. This is a short-term indicator that has spotted buying opportunities in this rally.
Traders are looking to buy, and I believe they will be buying this dip. And while I don’t believe the buying will last for long, I do believe stocks will move higher this week.
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