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February 6, 2023

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Don't fight the Fed.

The benchmark S&P 500 stock price rose 1.62% last week on the same old hopes that the Fed might moderate its restrictive monetary policy soon, that the economy might somehow avoid a recession, that corporate earnings may not be as bad as feared, or weaker earnings already may be discounted. Many corporations are cost cutting and announcing layoffs, which may help earnings but increase the probabilities of a recession, which could hurt earnings. S&P 500 corporate profit margins are on track to decline for the sixth consecutive quarter, according to FactSet. The fundamentals do not appear to be as strong as recent momentum and sentiment might seem to suggest, and stock valuations are not cheap by historical standards.

Technical momentum indicators for the stock market and investor sentiment have been rising, which is normal when stock prices rise persistently for a few weeks. Momentum and sentiment simply follow the short-to-medium-term price trends, and they can change suddenly and frequently. Moving averages have been crossed, but these lagging indicators are far from perfect and sometimes produce unprofitable whipsaw signals. Stock prices do not move in straight lines, so false upside breakouts do happen in longer-term bear markets before stocks resume their downtrend. The most shorted stocks have been performing best, suggesting that forced short covering has been a stronger driver of the rally than longer-term investment demand.

The Federal Open Market Committee (FOMC) increased its Fed Funds Rate by 25 basis points to 4.5-4.75% on Wednesday 2/1/2023, as generally expected. The FOMC statement said, "Inflation has eased somewhat but remains elevated.... The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time." The FOMC will continue to take into account "cumulative tightening" and "the lags with which monetary policy affects economic activity and inflation" as it makes future decisions.

In his press conference, Fed Chair Powell said that it is possible that the FOMC could update its policy path if the economic data comes in differently than the FOMC expects, and so the terminal Fed Funds Rate could be either lower or higher than the 5.1% the FOMC estimated in December. Powell said it was gratifying to see the disinflationary process getting underway with the labor market still strong, but there won't be a sustainable return to 2% in core services inflation ex-housing without increased labor slack. There is a path to getting inflation down to 2% without significant economic decline, but it may take more slowing in the economy than the FOMC expects.

As we have seen in recent months, the perpetually-bullish Wall Street establishment was quick to conclude that Powell may be shifting from his previous very hawkish stance toward something more ambiguous, possibly to give the FOMC greater optionality to modify monetary policy when needed. Friday's surprisingly strong employment report made it clear, however, that the labor market is going in the opposite direction from the increasing slack that the FOMC is looking for. Such strong payroll growth will not contribute to disinflation, will not encourage the FOMC to ease off its tightening, and very well may lead to a more restrictive monetary policy. The Wall Street establishment seems to have forgotten this time-honored wisdom: Don't fight the Fed.

The annual growth rate of the Real M2 Money Supply is collapsing like never before, which is likely to lead to an economic downturn. In year 2020, in reaction to the Covid lockdown economic crisis, the Fed inflated the money supply like never before, creating an economic and stock market boom. Such currency inflation means more and more money is chasing the available supply of goods and services, driving up prices and eroding confidence in the unbacked fiat money that the Fed creates out of thin air. Next, the Fed is forced to contract the supply of its fiat money (in an effort to save it from becoming worthless) and correct the Fed's own previous excess money printing. Rising interest rates and a contracting money supply lead to a contracting economy, placing severe stress on borrowers with weak financial positions. Debt defaults rise, lenders grow fearful and cut back loans, and credit markets collapse. Finally, the Fed is forced to reinflate the money supply and the cycle starts over with inflation rising again--only next time inflation starts rising from a higher starting point. The long-term result is declining purchasing power of the dollar. Over 104 years, the US dollar lost 96% of its purchasing power.

The Yield Curve (the spread or difference between the 10-year yield minus the 3-month yield on US Treasury debt, $UST10Y-$UST3M) collapsed far below zero to its lowest level in more than 30 years. When it fell far below zero in the past, a recession followed. Recessions are bad news for corporate earnings and for stock prices. A collapsing Yield Curve means that monetary policy is restrictive.

US dollar price reversed to the upside after completing a Fibonacci 50% retracement of its gain from January, 2021, to September, 2022. Short-term price momentum indicators RSI and MACD (not shown this week) did not confirm the recent 9-month price low and reversed sharply higher last week, suggesting bullish technical divergence. $USD remains systematically bearish below both SMAs (simple moving averages) and with the 50-day SMA below the 200-day SMA, but SMA systems usually lag at the trend turning points.

Crude Oil price completed a Fibonacci 50% retracement of its gain from April, 2020, to March, 2022. Oil also closely approached its 10-year average (not shown this week), for a reversion nearly to the long-term mean. Trends don't continue in straight lines, and that 50% retracement ratio might be a likely spot for a consolidation or an upside correction. On-Balance Volume remains stronger than price and therefore is diverging bullishly. The 43% price drop from June to December had a major influence on the easing of inflation measures in recent months, but that oil price downtrend already may have ended.

Copper price turned down last week after encountering resistance near a Fibonacci 61.8% upside retracement of its loss from March to July, 2022, and at technical chart resistance. Trends don't continue in straight lines, and this might be a likely spot for a rest or a downside correction. Copper remains systematically bullish, with price above both SMAs and with the 50 SMA above the 200 SMA. Copper is a leading indicator of the global economy.

Lumber price encountered resistance near its October high and its 200-day SMA. Lumber remains systematically neutral. On-Balance Volume has been stronger than price since its December low and therefore is diverging bullishly. Lumber is an indicator of the health of the building and construction industries.

Gold price reversed to the downside last week. Gold may have encountered chart resistance in the zone around its 2022 highs. On-Balance Volume also reversed sharply after reaching its 2022 peaks. Gold remains systematically bullish, above both SMAs and with the 50-day SMA above the 200-day SMA, but SMA systems usually lag at the trend turning points.

iShares Core U.S. Aggregate Bond ETF (AGG) price turned systematically bullish on 2/2/2022, when the 50-day SMA crossed above the 200-day SMA, and with price above the 50-day SMA and the 200-day SMA. RSI price momentum slowed in recent weeks, however, possibly offering an early hint of uptrend fatigue. On-Balance Volume has been and remains much weaker than price and therefore is diverging bearishly. Still high inflation and a hawkish Federal Reserve monetary policy are bearish for bond price--and also for stock prices.

The SPDR S&P 500 ETF Trust (SPY) price turned systematically bullish in January, when the 50-day SMA crossed above the 200-day SMA, and with price above the 50-day SMA and the 200-day SMA. On-Balance Volume has been and remains much weaker than price and therefore is diverging bearishly. There may be chart resistance around the August highs.

And much more...

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Analysis of market forces may offer a sense of probabilities. But the many variables that can impact market prices are notoriously difficult to predict. And, market analysis is something less than an exact science. So, sound trading tactics are always recommended. See my
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Robert W. Colby, CMT,
is a consultant to institutional and private investors and traders, providing regular analytical reports, custom research services, and trading systems tailored to clients' objectives. Clients include the most successful traders and investors in the world. Robert is the author of The Encyclopedia of Technical Market Indicators, Second Edition, McGraw-Hill, 2003, which has become the standard reference for indicator and trading systems design. Previously, at several large Wall Street firms, Robert worked as a proprietary trader, technical analyst, and fundamental analyst. He also was adjunct professor at New York University and New York Institute of Finance, where he developed new courses on technical analysis and market timing.

Robert W. Colby is a Chartered Market Technician (CMT), an accreditation granted to members by the CMT Association (https://cmtassociation.org/) after demonstrating professional competence and ethics over a period of many years. Robert has been a member since 1980, and he strongly supports the CMT Association's high standards. He also supports the The Technical Analysis Educational Foundation (https://www.taeducation.org/about/), which works to have technical analysis included in the curriculum of major business schools. "The CMT Association is the national organization of investment analysts, stock market analysis professionals, and certified market technicians in the United States."

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"Gold's next move: History, logic, and intermarket relationships. See if testing gold's relationship to different markets over a 32-year period provides possible trade signals for the yellow metal."
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"Which gold indicators are best? Divining gold's next move."
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"PUTTING CANDLES TO THE TEST, How Profitable Are They Really?" by Robert W. Colby, CMT. Published in SFO, STOCKS, FUTURES AND OPTIONS MAGAZINE, Volume 5. No. 8. August 2006, pages 91-94. Please click here to buy this article. (Scroll to bottom of linked page.)
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Active Trader magazine September 2004 interviewed Robert W. Colby. 4 pages. "Robert W. Colby: Technical collector. A discussion with Robert W. Colby about technical trading and his revised Encyclopedia of Technical Market Indicators, Second Edition. By Active Trader Staff."
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MetaStock® PC Software for Technical Analysis
MetaStock® is a powerful technical analysis software program for your personal computer. It offers more than 250 built-in indicators and line studies to enable you to explore a wide variety of methods. And it empowers you to build, back test, and optimize custom trading systems to suit your own particular requirements.

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