A possible end to the course rally

The US Federal Reserve had two clear goals until the day before yesterday: on the one hand, maximum employment in the labor market and, on the other hand, stable prices. For the latter, an inflation rate of 2% generally applies. We have known since the day before yesterday that the US Federal Reserve is now focusing more on the US labor market and that temporarily higher inflation will be accepted in order to achieve full employment. Given the current economic situation, this change in strategy seems absolutely understandable.

Goal of full employment vs. Inflation target

Because while unemployment in the USA is currently still in double-digit percentages and around 1 million people register as unemployed every week (see the day before yesterday’s internal exchange), the inflation rate has already risen significantly. The core rate had last risen from 1.2% in June to 1.6% in July and was rapidly approaching the Federal Reserve’s target of 2%. Here is the graphic from the Börse-Intern from August 13th:

U.S. Inflation (Annually)

Without adjusting the monetary policy strategy, the monetary authorities might have had to take countermeasures in a few months’ time to prevent inflation from overshooting. And that at a time when full employment is still a long way off in the USA, but rather unemployment is still very high. But now the central bank can keep its money locks wide open, even if inflation rises well above 2%.

Higher inflation keeps real returns low

Another advantage of this change in strategy is that real returns will remain low. In addition to inflation, inflation expectations have risen significantly – and thus yields on the bond market have also increased. After a brief setback, for example, the yield on 10-year US government bonds is striving to rise again (see green marking in the following chart).

10-year US Treasury bond yield

The day before yesterday, a new movement high of 0.72% was reached (which is not yet apparent in the chart, which currently only shows the return until August 26th). If inflation were now “capped” at 2% by the monetary policy of the central bank, real yields, ie nominal yields minus inflation, would continue to rise as yields continue to rise. And that could slow the economic upturn.

The day before yesterday at the online central bank symposium, the chief economist of the European Central Bank (ECB), Philip Lane, was critical of this. According to him, low inflation increases real interest rates, which is not good for economic recovery.

But if the US Federal Reserve lets inflation rise along with yields, real yields will remain low and the economic upswing can continue unchecked – at least in theory. Because, of course, it first has to be shown how much the returns and how much the prices will actually rise and how the real returns will develop as a result.

In any case, given these considerations, it is not surprising that, according to Lane, the ECB is also ready to adjust all of its instruments should inflation expectations that are too low make this necessary.

Fed creates the necessary legroom

It was not without reason that I had already written in Börse-Intern on August 13th that yields on the bond market and inflation (expectations) could be the big topic for 2021. And I asked the question whether the central banks could stick to their previous plans with increasing yields. Apparently the US Federal Reserve couldn’t do this. With the announcement of a more flexible inflation target (“Average Inflation Targeting”, also known as “asymmetrical inflation target”), it has given itself the legroom necessary to hold onto its (crazy) flood of liquidity in the coming months and (unfortunately also) years can. – I’m pretty sure that the bubbles this creates will cause us big problems.

A record that it is better not to set

And with that I come back to the exaggerations described the day before yesterday, which can currently be seen. I wrote that “the Nasdaq technology index is now so far removed from its 200-day line as never before in its history“. However, this only applies to the difference in points (see middle area in the following chart). In percentage terms, we are still below the record that was reached during the New Market bubble in 2000 (lower chart area).

Nasdaq 100 - Distance from the 200-day line

I don’t want to hope, however, that we will set this record in the context of the current bubble formation. Because some market participants should still remember well what happened after this record in 2000.

Like a cork in the water

Currently, however, as if by magic, any attempt at a correction in the US indices is nipped in the bud. Every dynamic setback is made up just as dynamically within a very short time, thanks to central bank liquidity. In Premium Trader, I compared this price behavior with a cork in the water. “The more you push it down, the more it sloshes up again“Was read in the weekly edition two weeks ago. And an end to this market behavior is not yet in sight.

Statistically, the autumn correction in the Dow Jones starts at the beginning of September

From a seasonal perspective, however, one should slowly adjust to a possible end. Because the readers of the premium trader got to see the following graphic a week ago:

Dow Jones - Seasonal Development in the US Election Years

It shows the seasonal course of the Dow Jones in US election years. And accordingly, the Dow Jones continues to rise regularly until the beginning of September, before it then goes down into October as part of the autumn correction. In addition, however, one could read: “Of course, these are only statistics and we are looking at an average price trend, so things may turn out differently this year. Especially since things are going differently this year than they normally are.

The remaining potential in the S&P 500 is 1.13%

But if you orient yourself to probabilities – and you should as a trader because the stock market is always only about probabilities – then you have to assume that the stock markets only have a very limited residual potential. And that does not only apply in terms of time (seasonally) if you look at the following chart of the S&P 500.

S&P 500 - Chart Analysis

You may remember from previous editions: the blue lines represented a possible trumpet formation. But the index obviously does not adhere to this. Due to the extreme price movements since the beginning of 2020, a broader trumpet formation appears possible with the red lines. And the S&P 500 has almost reached its upper limit line again. It is currently running at around 3,524 points, with an upward trend. The index itself closed the day before yesterday at 3,484.55 points. A residual potential of currently 1.13% is calculated from this.

In the current market environment, it would certainly be conceivable that the index could easily exceed this resistance line. But I don’t even want to imagine what happens when the index bounces off the hurdle and the seasonality initiates the continuation of the trumpet with an autumn correction.

You will therefore perhaps understand if I write to you again that I would still not dare to make new entries, advocate (partial) profit-taking and advise you to follow the stops on existing positions.

I wish you good trading success
Sven Weisenhaus


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