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The Breakout Will Be Tested
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It would be unusual for the market to run through resistance and not to test that breakout.
PRE-OPEN MARKET COMMENTS THURSDAY – The market ran through major horizontal resistance and it continued higher. Much of that move was short covering and we are about to find out to what degree. A trade deal with China shocked the market and the notion was that many other trade deals would follow. Now the focus is shifting.
Let’s finish talking about the trade deals. They have been slow to materialize and the market will get anxious. While we wait, we’ve heard from Japan that they are not going to rush into a trade deal just because of a deadline. Their economy is in a recession and tariffs could spell disaster for them. You can read between the lines that they might need to sell US Treasuries to free up money for stimulus programs. The US has to roll over $9T in debt this year and when you piss off buyers, they might not buy your bonds.
US Treasuries broke major horizontal support yesterday and the bond auction went very poorly. This morning bonds are down again. Moody’s downgraded US debt last week and that did not help. A hawkish Fed that only plans to cut rates once this year instead of three times is also keeping yields elevated.
I believe that Trump will get the message and he will ease up on the trade deal deadlines. The decline in bonds is a warning sign that the US does need it’s trading partners/debt holders.
Tariffs will lead to inflation and we are hearing that from retailers. If they absorb the added costs, their profits will suffer. If they pass the costs on to consumers, they will buy less. Tariffs are also going to lead to supply disruptions. In an effort to front run the tariffs, inventories were built up. That means the economic data points in Q1 were artificially inflated and that production will slow down in Q2.
The bigger issue is that global economic activity was slowing before tariffs. That undertow is present and it will impact the US.
The postponement of student loan repayment will end and hundreds of thousands of people will reduce consumption to pay those bills. JP Morgan Chase and Morgan Stanley increased their bad loan write down provisions dramatically. They are preparing for a storm and lending will tighten.
The news cycle will shift from trade deals and tax cuts to inflation and tight credit in the next few months. The House passed the “big new deal” and now it will go to the Senate. Republicans there said they won’t vote for it and that means it could get bounced back and forth for a few weeks. The market did not rally on the news and I view that as slightly bearish. It is one of the remaining upside market catalysts right now and this muted reaction will embolden bears.
From a technical perspective, the market is going to test the breakout. That could happen in the next two weeks. A gradual drift lower and a big bounce off of the 100-day MA would demonstrate that buyers are in control. A fast move lower with long red candles and a breach of the 100-day MA would be a sign that the breakout was purely mechanical and that it is going to fail. That would flush out bullish speculators and the backside could get nasty.
I don’t know which scenario is going to play out, but I can tell you that everything is not “peaches and cream”. Global bond and currency markets have been in a flux and that is typically a warning sign.
We are heading into a holiday weekend and normally the action subsides. Given the big drop in bonds yesterday, we could see decent activity.
We are one nasty day from the 100-day MA and I would watch that closely. If we drop to that level quickly, watch out. I would stick to day trading. We need to see how this plays out before we consider swing trades.
We have a flat open. The market has been able to stage nice bounces after weak opens. Given the sell-off yesterday, I would watch for a wimpy bounce to start the day. If we get that, I believe a good short will set up. Overseas markets were weak overnight. Watch VXX and TLT closely the rest of the month.
Support is at the 100-day MA and resistance is the high from yesterday.
This is my last report in May. Trade well.
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