Wednesday's Market Minute: Fireworks Ahead

We are likely in for some fireworks in the next three days. Yes, stocks have gone straight down for three weeks already, but the selling’s been fairly orderly, despite the dollar and Treasury yields both flying. Both are at fairly extreme overbought RSI levels and look due for a pullback that could set the stage for a bounce in stocks. It isn’t happening because economic data continues to beat expectations, and that’s emboldening Federal Reserve officials. As it should. The Citi Economic Surprise Index is the strongest since May. Despite the sell-off in stocks, the outlook’s actually improved since everyone was squabbling over how to define recession this summer.

Wednesday may be the last chance for bulls to stir a revival ahead of key economic data on Thursday and Friday. Jobless claims and anything employment-related are on a bit of a hot streak lately, and a better-than-expected durable goods figure could mean a positive GDP revision. Month-over-month PCE inflation is already expected to climb from the prior rate, and if the recent trend of strength carries over to inflation, well, you know what that means: look out below. If, however, we don’t get that washout sell-off, the VIX will have to come down dramatically, and that could mean a big rally into the weekend. Instead of betting on direction, bet on fireworks.  

While the technical setup for a bounce is compelling, investors should prepare to get comfy, because the evidence still favors a prolonged downtrend. Bloomberg columnist and investor Conor Sen pointed out on Tuesday that fixed-income markets are priced for the Fed funds rate to never again drop below 3.5%. A separate analysis by Bloomberg showed that bear markets typically trough at a price/earnings ratio of 12.6. It’s currently at 17.9. Yikes. None of this should be surprising if you’ve been following this newsletter. The dollar broke out from a seven-year range and Treasury yields are reversing a generational downtrend. These are not short-lived events. It’s probably best to get comfortable.

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