Coiled Spring Capital Macro Report 7/23/23

The stock market confounded the skeptics again and posted a decent week in the face of some very turbulent action (especially in the Nasdaq) as well as a very publicly debated OPEX on Friday. The difference this week, was that the Nasdaq bore the brunt of any weakness while the Dow powered higher. This is a notable change of structure, but 1 week does not make a trend. Recall that there was also a rebalance in the largest market cap companies, that theoretically was responsible for a large part of the rotation. Meaning, as funds rebalanced, they sold the top 7 market cap stocks and rotated into other companies and sectors. This very easily could be the reason for the dichotomy in the indexes. Does this reverse next week as the technical selling is largely done or is it the start of something more meaningful?

The upcoming week is chock full of market moving news, most notably the FOMC meeting on Weds, followed by more large cap tech companies and 1/3 of the SPX reporting their earnings. This leaves us with some very open-ended questions that may get answered this week. Primarily, does the Fed indicate their intent to re-accelerate their hiking guidance or do they pause after hiking this week. We suspect they pause, which could be construed positively by the market. But as always, trying to predict the actions of the Fed is a difficult game. Currently Fed Fund Futures are pricing in a 96% chance of a hike this week and only a 32% chance of another hike by Nov. Cuts are now forecast to start in May of next year.

We will also get the Fed’s preferred inflation reading at the end of the week (PCE), along with consumer confidence readings. The last PCE report surprisingly slowed more than expectations and the stock market rallied into mid-July. The current expectations are for more moderation. Recall that the recent moderation in inflation data has pushed the Fed Funds Futures probability of further raises much lower, so we can assume that this figure carries significant weight, but we think it will be more in-line with expectations and likely not market moving. Core inflation remains a bugaboo for the Fed as its still sitting at 4.8% vs the Fed’s target of 2%, and that data won’t be released for another couple of weeks. Couple that with stubborn employment, which has cooled but still expanding, and the Fed remains in a difficult spot. This makes the Fed speak quite binary and tough to predict as they know there is more work to do but they seem comfortable with the soft-landing narrative. If they push too far, do they break the serenity? It’s certainly possible and why we have opted to raise cash this month into the residual market strength.

Remember, tops in the market are a process. Typically, you do not get some sort of cataclysmic move lower to start a downtrend. Usually that requires new information. Could this information be the FOMC? Sure. Could it be very poor outlooks by the companies reporting this week? Of course. When we get defensive, it’s because we think the risk/reward is not favorable. That doesn’t mean we are negative on the market and to blindly short it. If you are confused by our messaging, we encourage you to re-read our past reports. I’ve taken the pertinent info out of each of our reports this month to illustrate our positioning.

*We entered the last week of Jun fairly cautious but the action that week had us admitting we were too early and flipped back bullish. We were unequivocally bullish heading into July. The title of our report was “Are the bulls back so soon.” Here is the excerpt from our mid-week report from 6/28:

*In our July 3rd weekend Macro Report, we very clearly discussed how bullish the structure of the market was: “The structure of the market is undeniably bullish.” Here is the excerpt from our conclusion section:

*In our 7/9 report we discussed the notion of “Clear and Present Danger,” which means there are some lingering issues that could impact the market at any time. But very clearly mentioned that we are technical analysts first and follow a strict methodology to determine stock market direction. Here are a few excerpts:

“Have our fundamental concerns evaporated? No. But who are we to argue with price action? Price action is the most important of all metrics we track. Price action is the collective wisdom of $trillions of capital, of some of the most well-resourced and sophisticated participants in the world. Who are we to argue with them? The bigger question, why are you?”

“…the post suggests a rebound this week, especially for the Nasdaq.”

“…index construction is weakening and on the verge of a trend change. While not confirmed yet, we still think upside will be limited from here and using any excess strength to tighten stops and take trades is wise.”

Limited upside does not mean we are negative, it means we are looking to raise cash into more index upside, which is what occurred. In the context of an SPX move that garnered almost 1000k points since we started getting constructive in Oct ‘22, another 100 points of upside is fairly limited. We have talked repeatedly about the easy money in the market having already been made, and limited index upside is what this encapsulates.

While index upside is a concern, it must confirm for us to get bearish, which it hasn’t. Limited index upside hasn’t precluded us from adding long exposure as evidenced in our last few reports. Rotation into other sectors is bullish, which means the indexes can chop around and do very little, while the rest of the market catches up. We want to be in the catch-up plays and why we recommended buying small caps back in late Jun. Small caps ($IWM) are up +8% since that report. +8% for an index is enormous alpha, especially in 3 weeks’ time.

A huge part of our methodology is the presence of DeMark signals. When they are not present, we are not calling for trend change most of the time. Sometimes predicting when they print is difficult because certain sequences and conditions must get met before they do. Usually, we will find the signals to get pushed out from our original thinking, which usually delays our cautious stance. The bottom line is until they print, we are not calling for trend change. That doesn’t mean we won’t be selling into residual strength.

*In our July 12th mid-week update, we very clearly stated:

“To conclude, we think the time is upon us to start being more defensive. This means taking trades quicker if you do not have duration or playing a bit more defense. This does not mean to outright short the market. The DeMark signals are fantastic for calling turning points, but we like to see more confirmation with our other signals first and that has not happened yet. Could that change tomorrow, yes.

And from our 7/16 weekend Macro Report:

“We do feel that the stock market is beginning to run on fumes as we approach some identifiable target zones described in the aforementioned. This is happening concurrently with DeMark sell signal confluence in the indexes. We also believe that macro factors may start to bite into the market’s enthusiasm over the next few months. Couple this with a difficult seasonality period of low liquidity, and we prefer to start being more defensive to protect our gains.”

And lastly, in our last mid-week report, we very clearly identified how much we have been selling into the market strength. Without rehashing all the excerpts, here is the performance of those ideas:

$SCHW +20%; $PYPL +12%; $SQ +12%; $BAC +9%; $KRE +25%; $IWM +8%

We went on to discuss the rotational sectors we remain involved in and added to some last week. We will keep these under the paywall for now. If you have interest in learning where we are putting our chips, please consider subscribing below.

The bottom line is tops after such a large move in the indexes, are more of a process. When we see the risk/reward not as favorable, coupled with some of our signaling methodologies flashing caution, we want to pull back our aggressiveness in the stock market. We only want to be aggressive when the conditions are right, and per our process, they are not. Does that mean the market has to have a 10-20% correction? Not at all. The market could just start carving out a higher range. Given that we are headed for a seasonal slow period, we want to be in a position to be opportunistic should we get those opportunities.

We have talked about this upcoming earnings season as a potential pivot point for the market. Do companies increase their outlooks for the year as per the estimates suggest or do they shock the market with much lower earnings trajectories. We honestly do not know, but we do know the market is pricing in growth so anything but, will be a disappointment. Thats a precarious set up to be aggressively long, and hence, why we are not.

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