After the jaw dropping 8% rally in S&P 500 during August, the first week of September took the wind right out of the market's sails in three days, as it dropped down towards 3,290.
After the S&P first tested its 21-day moving average, the holy grail level, whereby all the buy-on-dip crowd ignore any pullbacks, it then proceeded lower toward the 50-day moving average. The pattern was similar in the Nasdaq -- in fact it was this index that caused the profit-taking from extremely overbought levels in August; we all know the S&P 500 index is just a reflection of the Nasdaq, given the large five or six names that dominate its momentum, for now. the market is confused whether this is the start of a much bigger pullback, or just a short-term unwind from an overbought position in august. The jury is out and the Fed might just hold the key as it deliberates Wednesday.
Technically speaking, we have not broken any of the uptrend levels from the March lows, but if the market does falter from here, then all the algorithms will be flashing red and we know all those pent-up longs will soon rush for the exit. Fundamentally -- well, this market was never about fundamentals. It has always been about liquidity and central banks boosting asset prices. The Fed has kept their balance sheet on hold over the past month and a half, just buying the minimum Treasury securities it needs to. After the initial post lockdown-ending economic boost, macroeconomic indicators are showing signs of stalling here. The economy and the market needs its next boost, whether it is fiscal or monetary. The Fed is relying on the fiscal side of things to take over as they have done whatever they can for now to jump start the economy; they flushed it with cash.
We were supposed to hear of a fiscal stimulus bill by end August. The two sides still have not met on common ground and the debate carries on. The longer we wait to hear on this, the slower will be the recovery and longer it will take. The U.S. consumer has now used up its stimulus checks, and is waiting for the next tranche to regain the confidence. Jobs are coming back, but more and more temporary layoffs are becoming permanent. We are far from a "V"-shaped recovery. some stocks and sectors like technology have recovered and then some, but that's only a handful of names.
What can the Fed say today? It is expected to keep rates unchanged and continue with the current rate of asset purchases. It will probably not talk about yield curve control until it gets to be a problem, if inflation does take gross yields higher. The Fed is more worried about deflation than inflation for now. It is at odds with the market that is focused on inflation being a bigger problem and bidding up inflation proxies. Given the market is down just 6% since its highs, and we are still above the March 2020 level, it is highly unlikely the Fed to come out and suggest a bigger quantitative easing program. It would only do that if the market were to fall down 10% or more, as it would come to its rescue.
The dollar is key to the markets here and everyone is very short, according to the Bank of America (BAC) fund manager survey (formerly the Bank of America Merrill Lynch, or BAML, survey). It is taken for granted that the Fed will keep printing and the dollar will be source of all shorts in the market. If liquidity does start to tighten up again, as the global economy is showing signs of stalling, then the dollar could be at risk of a major squeeze, which would hurt all stocks and sector positioning. The ball is in Fed's court, perhaps it will keep leaning over the dollar via dovish statements and keep the rally going? After all, it doesn't take actual money printing, just the hint of it, to get the buyers to come back in and keep the party going.