Momentum Monday – The Inflation Trade Is Dominating the Tape

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The main premise behind the summer rally was that the Fed is going to pivot because of the possibility of overdoing it and causing a severe recession. This was the market’s bet. As a result the stocks that were hit the hardest since February 2021 due to rising interest rates – like biotech, were among the best performers in the past couple of months. On Friday, Fed’s chairman was very clear that the Fed is not ready to change its tightening policy just yet, and bringing down inflation continues to be the main concern. It seems his words sobered the market up fast and caused a major selloff across the board – biotech, semis, software, retailers, financials, industrials, consumer discretionary, etc. 

Last week was the second down week in a row for the main indexes. Both, the large-cap S& P 500 (SPY) and the small-cap Russell 2k (IWM) tested their 50-week moving average two weeks ago and have pulled back about 6-7% since then. The next potential zones of support are their 50-day moving average: about 398 for SPY and 181 for IWM.

The only market areas that have handled the selling in the past couple of weeks relatively well are commodities – energy like oil & gas, coal, uranium, solar; fertilizers, and industrial metals. Those groups were clear leaders in the first half of the year but then underwent a deep 30-50% drawdown during the summer only to bounce back later. The inflation trade is back on. The question is for how long? If the market is really worrying that the Fed’s tightening policy will lead to a severe recession, then those groups will start to crumble as well.

Typically, future market leaders build new bases while the indexes correct. It’ll be interesting to see if the current leaders like ENPH, FSLR, LNTH, SWAV, EVH, GFS, ON, WOLF, TMDX, CELH, and others will simply remain above their 20 and 50-day moving averages while the indexes potentially sell off further. From a strictly seasonal perspective, stocks tend to be weak ahead of the mid-term elections and strong after. Obviously, there are many other factors currently at play. I will remain nimble and take things one week at a time.

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