Are we facing disinflation – and then deflation?

There was a deluge of US data last week which traders took to be generally bullish for shares and positive for the economy. This the power of momentum at work. Actually, it doesn’t matter what the numbers were – if the consensus believes they justify higher prices, they will push them higher. That makes the vast majority of the screeds of lineage from the vast army of MSM pundits it disgorges as immaterial.

What matters is the price and the price action and the Elliott waves created by the interplay between the bullish and bearish forces (which are constantly changing).

And one more thing – I talk a lot about sentiment (the rough measure of the overall bullish/bearish balance). Even this is not a satisfactorily accurate way of measuring market mood.

Take the simple imaginary case of a market where 99% of the traders are bullish (or claim they are – a different thing!). Say the 99% are small traders with limited resources who have fell in love with a convincing story. And the 1% are a few huge hedge funds with almost unlimited resources. Evidently, the market is way overbought with all momentum and RSI oscillators at extremes.

Normally, we would say the market was ripe for a major correction. But not necessarily here – only one hedge fund who is short could decide to cover a large fraction of the open interest shorts – and shoot prices to the moon. All the while, momentum oscillators remain stuck at extremes.

In fact, that is what usually happens in real markets where large funds are being forced to cover in a short squeeze. This is much more common in commodities. It never happens in stock indexes or currencies or the T-Bonds where there is normally a rough balance between the bulls and bears.

A recent example is Sugar (covered in my blogs recently). The rally phase this year from 19 cents to the 26 cent high was accompanied by much hedge fund short covering.

So, is inflation licked – are we heading for disinflation and then deflation?

The Nasdaq was the only US index that gained last week. The Dow suffered its second consecutive down week. They were swung around by traders reacting to the data deluge which was generally seen as positive and pointing to a highly likely Fed June pause and perhaps even a pivot later this summer.

The CPI and PPI inflation data were about in line but on Friday the U of Michigan released its respected Consumer Sentiment survey data that showed Inflation Expectations dipped only slightly to 4.5% for the coming year. But the 5-10 year forecast showed a huge jump to a level not seen since 2008. And Consumer Confidence (on the economy) slid against expectations.

This is not a picture the Fed wants to see. It obviously wants consumers to lower their inflation expectations (towards their 2% target) and act accordingly to take some heat out of the economy. Hmm. More ‘encouragement’ via ‘higher for longer’ rates may be necessary – or will be provided by the market?

And just released – it appears deflation is just around the corner. April US import and export prices slumped 5% – 6% YOY, That’s massive. And the same is happening in China. So both consumer and producer prices are heading much lower (but probably not so much in the UK whose inflation figures have always been sticky)

With industrial metals heading sharply lower, this is all adding up to a huge wave of disinflation and then deflation ahead. In fact, we have deflation already (falling prices) in some sectors such as EVs. Stocks of used EVs have risen dramatically and prices are falling hard. This should impact new prices in turn.

So have the US stock markets caught on to this developing scenario yet? The Russell 2000 contains small and medium caps of primarily non-tech companies. These sink or swim by real profits, not some starry-eyed vision of profits to come (I am looking at you, AI).

In recent weeks, it has lagged the performance of the Nasdaq and is my top index for downside action (for now)

In common with all other US indexes, it made its ATH late in 2021 and has been in a wide trading range for over a year. That has made trend-following strategies difficult although the wide swings have been available. Trading the indexes has not been a ‘set and forget’ operation.

But my wave labels are clear – we are in a large scale third wave down off the wave ‘c’ of 2 high. For us the big question is this – is the super-strong support at around the 1600 region in imminent danger? One factor that could determine that question is the path of the US dollar.

How will an advancing dollar impact shares?

On Friday, I got my clearest signals yet that the dollar is starting a weeks/months long rally phase – after much indecisive action that I have been wrestling through seemingly for weeks. And one of the signals was my observation that there was a sudden recent deluge of pundit pieces forecasting the Death of the Dollar in recent days.

The bears cite such factors as the looming Debt Ceiling drama with booming National Debt levels, the switch out of the dollar to the yuan for more international commodity deals, and the ‘improving’ EZ economy that has put upward pressure on the euro.

But as the old-time trader Joe Granville maintained: When everyone agrees that something is obvious, it is obviously wrong.

So when I see such an eruption in negative comment, I start to look the other way – and yesterday’s surge was a textbook case of how that can be a profitable stance.

It has been a long wait but odds strongly favour a very sharp rally phase with my first target at 105. With credit risks growing all around, I believe the dollar will be increasingly seen as a safe haven (away from the yen, the traditional haven of safety, or Gold).

And could we really have a Debt Ceiling crisis on our hands? Is the government spending spigot finally being turned off? If so, it will be the first time in history so let’s not get too carried away (yet).

And fuel for this Bonfire of the Bears will be provided by the extreme positioning in futures. Hedge funds are over 3/1 long/short the euro (COT data) – and the huge momentum divergence at the wave ‘c’ low.

And DSI bullish sentiment towards the euro is at an extreme over 80 reading. Hmm.

Of course, an advancing dollar usually implies US market rates will not decline soon and may actually move higher, contrary to what most pundits and equity bulls expect. That would certainly surprise a lot of people!

So we have a classic setup for a scenario where most are looking at a lower inflation rate as being bullish for shares (lower Fed rates) – but will likely turn out to be quite the opposite. And the newly advancing dollar surely tells another story. Will a lower inflation rate be accompanied by higher interest rates? Stranger things have happened.

And the more evidence inflation is on the way down will be seized by dollar bears as another reason to short the greenback – into a rising market. this promises to get real exciting.

Treasuries are in a secular bear market

For over two months, Treasuries have been in a trading range, but should be close to breaking out to the downside with yields moving higher again.

and this could be a H&S reversal pattern near completion which a break of my neckline would confirm. Thus, a rise in long term rates would set the large Elliott wave 4 in place as the Head and herald a large wave 5 lower.

And this would conform nicely to my advancing dollar thesis with interest rates and bond yields rising against expectations.

Thus, we are on the cusp of a likely mammoth move in rates, yields, currencies, PMs and shares.

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Bitcoin is falling into line with my overall bearish scenario

I updated my Bitcoin coverage for VIP Traders Club members yesterday and noted the likely Head & Shoulders reversal pattern forming. And later on Friday the market broke below my neckline to confirm the pattern as heralding major declines ahead.

And I have a massive mom div into the Head which will herald the sharp declines ahead.

The appearance of H&S patterns in several markets is not a coincidence. Such a pattern reflects powerful tug-of-wars between the opposing bullish/bearish forces that are being worked out before one side wins and the other collapses in a heap of exhausted bodies.

Remember, this is one of my two litmus tests for the state of sentiment towards the economy. (The other one is Tesla which also fell heavily yesterday). I should call it the BT Test, although certain telephone engineers might get the wrong impression. And TB would do likewise for medics. Hmm.

Another thought on trading these markets

If you are a ‘fundamentals’ based trader and believe markets are driven by the data and the news, you would have been thoroughly confused by last week’s market action.

The US economic data seemed positive, yet the Dow closed down the the week. And respected prominent voices were proclaiming the banking crisis is a non-event with all regional banking problems contained.

Of course, we all know they all say that when a banking ‘difficulty’ arises. They all said that in 2007 ahead of the greatest banking crisis since the Great Depression materialised.

They try to soothe investor’s fears and prevent huge bank runs, of course. But some banks’ shares were still making new lows into the week’s close.

So does following the news make a good trading strategy?

I do not believe so (unless using the news as contrary indicators) and it is technical analysis that can offer greater insights into what is about to occur. And it is the Elliott wave model that can most accurately describe the path forward.

The the days ahead will show whether my reading of the waves will produce the results I anticipate.