There have been a lot of questions asked related to the market strength we have seen the past few weeks. Is it sustainable? Is what we’ve seen a typical bear market rally? Two weeks ago, on the vlog, we mentioned an indicator that we watch that looks at market strength. That indicator shows what percentage of stocks are above the 50-day moving average. Two weeks ago, only 68% of stocks were above their 50-day moving average, however, according to the chart shown in this episode, after last week’s rally, the percent of stocks trading above their respective 50-day moving average broke through that important 90% threshold. That’s marking the best reading since April of last year. The persistence and the breadth of momentum, which is what this indicator attempts to measure, is a welcome change for the prior rally attempts that failed earlier this year. The market still has some near-term hurdles to contend with since many of the indices are now overbought. Seasonality won’t offer much help over the coming weeks, and the downward sloping 200-day moving average is still above the S&P and the NASDAQ. The momentum is strong, but we still need to get through some things in the near-term.
Inflation is at the top of mind for everybody. Everyone sees inflation on a day to day basis. It is there especially when you go to the grocery store or fill up your gas tank. The way we are looking at it, is more on how it impacts the markets. The Fed having a $9 trillion balance sheet is the biggest mover in the market right now and for the foreseeable future. We received great news last week about inflation falling from 9.1% to 8.5% year over year. That is still high, but there has to be a peek and roll over before it can come down. What does that mean for the Fed? Historically, since 1970 the Federal Reserve has raised rates continuously until their federal funds rate is higher than the rate of inflation. Now, if you say the federal funds rate, which currently sits a 2.5%, needs to go to 9% to kill inflation, that would be very disruptive. We need to see inflation decrease while the Federal Funds Rate goes up. You can see on a chart shown in this episode that every rate hiking cycle has ended with the federal funds rate being higher than the inflation rate, so both need to happen. We need inflation to come down, but we would expect the Federal Reserve to continue to raise rates into that number. Where they meet in the middle is the biggest question for the market. How far down the road is the market expecting it, is what drives the current rally. We may be a little over bought, buying into an inflation relief rally. Peak inflation does not mean peaking interest rates, but it is something we’re watching very closely.
With the recent passing of the Inflation Reduction Act, one of the lesser-known clauses in there is a 1% buyback tax, which is going to start on January 1, 2023. The good news about this tax policy is that it’s a one-time change and companies can plan ahead since they have a little bit of advance notice. Companies may start to buy back their own stock and we could see some pulling forward of additional buybacks. This is one way for companies to return cash to shareholders. That could be something that we see at the end of the year and could be a sort of catalyst if companies are buying back excess stock. Another change that could happen after January 1st, is the possibility of more dividend increases as opposed to the buybacks because of the tax policy change.
We saw a good bit of momentum in the overall markets last week with 11 sectors finishing in the green on both Wednesday and Friday. The S&P 500 closed on Friday at a price of 4,280 giving us a new resistance level of 4,310 and a new support level of 4,250. Back in late spring, early summer, we talked about the price mark of 4,200 being something to watch. We have now crossed over that, so we are now focusing on the 200-day S&P 500 moving day average, which is currently sitting at a price of 4,328. We will be watching to see if this momentum can continue through the fall to see if we can get back over that 200-day moving average price of 4,328, which is an important indicator for the markets.
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