Changing our macro outlook, short-term caution in the precious metals
Things seem to be unfolding differently than expected. At Cycle Investment Strategy, we maintain an open mind to respond to changing market conditions and new data. Yesterday, we issued a market warning in light of several indicators suggesting a potential correction in the broad US indices. The S&P 500 and Nasdaq may appear to be in an uptrend, but there is already underlying weakness in these indices.
Weakening Market Breadth
The number of stocks making new highs is falling, while the S&P 500 continues to rise. Similarly, the percentage of stocks above their 50-day moving average is declining, even as the index pushes higher. This pattern has historically preceded more significant market corrections.
We saw similar behavior before the major March 2020 correction, when this divergence and breakdown in breadth became evident.
Risk-Off Movements and Defensive Sectors
Defensive sectors are starting to outperform cyclical sectors, which challenges the economic recovery we have anticipated. This shift could point to an emerging risk-off movement, where investors are starting to move away from riskier assets in anticipation of economic uncertainty.
Dollar Strength and Commodity Positioning
The positioning of smart money (commercial traders) in the dollar is historically high. This strengthens the argument that the dollar strength will likely continue, aligning with an emerging risk-off sentiment in the market. The dollar recently made a fake downward move, only to break out, signaling sustained strength in the currency.
We do not foresee inflation cooling down. On the contrary, commodities, particularly oil and agricultural products, remain bullish, and charts suggest these commodities are bottoming out. Smart money has significantly increased its position in crude oil, signaling an impending rally, while positions in corn are at historical highs, pointing to an upcoming surge in corn prices.
The Shift Toward Stagflation
We are now leaning toward a stagflationary scenario rather than an economic recovery. Leading indicators, such as temporary help services, are already signaling a downturn, indicating we may be in the later stages of the economic cycle. This has been a long-term trend, present for almost two years now.
Stagflation—characterized by slow economic growth, high inflation, and rising unemployment—would particularly benefit precious metals, especially gold and silver, which often perform well in such conditions. However, we anticipate some near-term weakness in these metals as they still have to factor in interest rate cuts. Additionally, the COT data for gold remains neutral, suggesting potential short-term weakness, especially given the strength of the dollar, which may further dampen gold’s performance.
Potential Opportunities in Precious Metals and Small Caps
While gold may face some temporary challenges, silver could soon see a rally if our trading system signals a buy in the coming weeks. Small-cap stocks are also expected to perform better during this stagflationary environment, as they are more sensitive to inflation and economic growth.
What’s Underperforming?
Large-cap tech stocks and the mega-tech companies may not benefit from the reflation trade. The sentiment surrounding these stocks is extremely bullish, with most investors overweight in them. Rising long-term interest rates are likely to weigh on the high valuations of these companies, especially as stagflation pressures mount.
Additionally, cyclical companies tend to rely on short-term financing, while larger tech firms have already secured favorable long-term financing, making them less sensitive to changes in interest rates.
Conclusion: Preparing for Stagflation and Market Corrections
Given the current market signals, we advise against shorting the market at this time. The underlying weakness may not immediately affect the indices, as the ongoing buying panic in large-cap stocks could continue for some time. At this point, it’s wise to stay on the sidelines until further signals emerge.
We continue to watch precious metals, commodities, and small-cap stocks for potential opportunities in the stagflationary environment, as they are more likely to benefit from rising inflation and economic uncertainty.
We wish you a strong start to the week and look forward to providing more updates as the situation evolves.
All the best,
Cycle Investment Strategy