Morning Comment....The Dollar is Testing Key Support
Friday’s weaker-than-expected employment report led to a sharp drop in long-term bond yields…and to higher odds that the Fed will cut interest rates this summer. This, in turn, led to a strong rally in the stock market…that took the S&P 500 index up to its 50 day moving average (50 DMA). (We’re sure algos played a role in the pronounced rally as well, but most pundits never give them credit for rallies…only blame for out-sized declines.)….We also got positive news on the trade front…when it was announced that new tariffs on Mexico could be delayed. Over the weekend, the Trump administration came to an agreement with Mexico…and no tariffs will be initiated. So the market is seeing some upside follow-through the pre-market trading this morning.
In other words, the sharp near-term bounce we called for a week ago this morning has indeed come to fruition. However, the “internals” that we saw during Friday’s rally were not very strong…and thus have deteriorated from earlier in the week. For instance, the composite volume was only 2.6bn shares. That was 14% below the 2019 average…and much lower than it was earlier in the week. This shows the enthusiasm for the bounce was loosing a little steam by Friday. (It was also the third lowest volume day since the beginning of May…2<sup>nd</sup> lowest if you throw out the day before Memorial Day weekend)……Breadth was also disappointing. The advancers vs. decliners were only 3.1 to 1 positive for the S&P 500 and just 2.5 to 1 for the NYSE Composite index. This was less than half the readings we saw earlier in the week…when the market rising in a similar fashion.
We’d also note that the leadership in last week’s rally included defensive groups like the utility stocks and consumer staples. This is exactly what we saw during the mid-May bounce…and that one faded quickly (and was followed by lower-lows). Finally, a lot of the oversold condition…and a lot of bearish sentiment…has been worked off, so there are a lot of reasons to think that this bounce has runs its course (or at least has come close).
Having said this, last week’s rally took the S&P above its very-short-term trend-line from the beginning of May…and up to its mid-May highs. So it won’t take much upside follow-through to give it a minor “higher-high”. Therefore, there are certainly some technical reasons to think the market will continue to rally from here. (1<sup>st</sup> chart attached below.)…….However, the most important reason that most people think the market can rally further has to do with the Fed. Given their recent shift (by jawboning in a more dovish fashion)…and the weaker data we’ve seen recently…a lot of people believe the Fed will cut rates very soon and thus add the kind of liquidity to the system that will take stocks well above their April all-time highs.
The problem with this assumption is that the history of the past 10 years shows that the Fed is AT LEAST as much “market dependent” as they are “data dependent”…and they do not engage in simulative programs until the market falls much further than it has so far over the past 5-6 weeks. Therefore, we believe those who are looking for a rate cut by the Fed before a further decline in the stock market (a measurable further decline) are getting way ahead of themselves……Of course, we could be dead wrong. Maybe the Fed doeswant to engage in “insurance” rate cuts. Maybe they will indeed bow to the pressure from President Trump…and buoy the economy from ANY weakness what-so-ever…in order to help him get re-elected. Yes, the employment report was on Friday was weak, but NOBODY is saying the employment situation in the U.S. is anything but strong. We’re just not as convinced as others are that the Fed will act…unless we get much more stress in the economy & the markets.
Changing gears a bit, we just want to once again highlight the weakness we’ve seen recently in the dollar. The DXY dollar index is bouncing a bit this morning…and this bounce is coming off of a retest of its 200 DMA. The 200 DMA has provided rock solid support for the dollar all year, but it is also where the trend-line from the early 2018 lows comes-in. So any break below that level would raise a yellow flag on the greenback……..We’d still need to see it break below its February/March lows of 96 (and maybe even its January lows of 95) before we could raise a red flag on the dollar…and confirm that its intermediate-term trend has changed. However, a break below that 200 DMA would still be important…and would almost certainly have an impact on other asset classes (like commodities and emerging markets). Therefore, we’ll be watching the currency markets very closely in the days and weeks ahead.