Seventeen months ago, the global economy was in free-fall. In fact, it was all but shutting down. This, in turn, caused the fixed income markets to freeze-up. Customers were even having a tough time getting Wall Street firms to make a market in U.S. Treasury bonds in overnight trading! In other words, the economy and the marketplace were in the middle of one of the worst emergencies in history. Then, the Federal Reserve stepped-in with several emergency programs that helped us as we were staring into the abyss. (That’s right, the situation in March 2020 was at least as dire as it was in 2008.)
In other words, the Fed did an unbelievably GREAT job in helping the world pull-out of the death spiral it was in during the spring of 2020. If Chairman Powell and the Fed has not provided the massive emergency relief that they did…at a time when it was absolutely needed...a serious financial melt-down was a distinct possibility (a probability in our opinion). Sure, some people will say that we’re exaggerating when we say all this, but we believe that those who say this don’t understand how truly bad the situation was in the month of March 2020……(Of course, other global central banks deserve some credit as well, but Chairman Powell and the U.S. Fed were the ones who moved first…and those other central bankers followed.)
The question now is whether or not those massive emergency programs are still needed. We have been saying for a while now that those programs need to be pared back. Neither the economy nor the markets are in an emergency situation anymore, so we think that the Fed should begin tapering back on their biggest program (their QE program). Unless the Fed is aware of some ugly situation that is just over the horizon, they should be paring back their stimulus/liquidity.
This morning, we will get the CPI data that will give us an idea if the rise in inflation that we’ve been experiencing this year is accelerating. (We get the PPI tomorrow morning.) Last month, this data was quite strong. However, it followed some weaker-than-expected employment data by less than a week. This time around, it will be coming after a stronger-than-expected employment report. Therefore, if (repeat, if) the inflation numbers are strong, it should have a bigger impact on the markets than it did in July. More importantly, it should also have a bigger impact on the Fed’s timing on when to start tapering back on their bond buying program.
Shifting gears a bit, we want to highlight that the high yield market is seeing some renewed weakness this month. We saw a similar move in the middle of July, but it was able to recover its losses quite quickly in the second half of the month. Therefore, we don’t want to make too much of the weakness we’ve seen over the past week and a half just yet. However, if (repeat, IF) the HYG high yield ETF falls further from its current level, it will raise some concerns in our minds.
The high yield market can be a good leading indicator for the stock market. No, it’s not always a LEADING indicator. Sometimes it a coincident indicator…and thus it sometimes changes it trend at the same time the stock market changes. However, the weakness in the HYG in late 2017 signaled the correction we saw in Q1 of 2018. (It also underperformed in the weeks leading up to the Q4 correction of that year as well.) More recently, in August of 2020, the HYG began to act poorly…even though the stock market continued to rally…just before the September correction of last year in the stock market.
Again, we don’t want to overstate this development quite yet. However, the HYG has been weak lately (and spreads have widened out a bit recently as well)…..Right now, the HYG is testing its 200-DMA. It has already broken below its trend-line from last September (the last time it broke below its 200-DMA), so if it continues to fall, it’s going to raise a yellow warning flag on the high yield market…and on the stock market as well.
The level we’ll be watching if the HYG does indeed break below its 200-DMA is the 86.60 level. That was the low in May (on two occasions), so if it breaks below that level, it will mean that the high yield ETF had followed the break of its trend-line and a break of the 200-DMA…with a key “lower-low.” THAT would change the flags on both markets from a yellow one…to a red one.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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