A deflationary event appears on the horizon which should impact both stock and precious metals markets over the weeks ahead. Let us place the expectation into proper context given developments over the last week.
US Elections and Federal Reserve Meeting
The US elections on Tuesday fell fairly in-line with recent poll forecasts. Republicans retained control of the Senate, while Democrats regained control of the House of Representatives. Most markets were flat the next day, although stocks rose on Wednesday into their retest zone (see chart, next page).
The Federal Reserve meeting came and went also with little reaction from the markets. As predicted by the futures market last week, no interest rate hike was announced by the Fed, leaving the bank-controlled short-term rate steady at 2.00% – 2.25% until the next rate hike likely coming in December.
Noticeably absent from the meeting was any language hinting of concern over the recent declines in the US stock market. The Fed, it seems, is not concerned that there has been any material degradation of financial conditions.
The dollar was marginally higher by 0.5% following the meeting and into Friday, which is partially what accounts for gold’s weakness toward the end of the week.
Fed Reaction Psychology
Market psychology regarding interest rate hikes is sometimes perverse, which is why we try to tune out the noise unless major trends are violated. For example, for several years during the 2011 – 2015 advance in US stocks, “bad” news (higher unemployment figures, lower manufacturing numbers) would result in the stock market rising that day – as the market believed that because of the negative news, the Fed would be less likely to hike interest rates at the next meeting. Bad news was good news, and good news was bad news, when it came to predicting the Fed’s decisions.
In contrast, our suspicion is that presently, should the Fed not hike in December (generally “good” news for stocks), the market will perceive this as a negative, as it will be taken to mean fear is prevalent within central bank thinking.
It will thus be important to watch the market’s reaction during the next meeting on December 19. In which another 25 basis point interest rate hike is already being priced in by the futures market. Such a forecast indeed assumes the stock market does not witness further declines. Which is exactly what is predicted by our trend model.
Deflationary Event
We expect that a deflationary event is setting up over the next several months which should negatively impact most world markets and may place a firm bid under gold and other precious metals.
Whether this deflationary period will be isolated or whether it will alter long-term trends, especially the bull markets in US stocks which began in 2009, remains to be seen. However, the writing is on the wall that a period of declining asset prices is due ahead.
Let us turn to the stock market. US stocks rose for the second week in a row, rising 2.1% or 58 points, to close at 2781 on the S&P 500 index.
The intra-week high was 2815. Note how stocks were stopped at the now-broken (BLUE) trend which began with the February 2016 lows. The important point for us to recall at this moment is the technical adage: “The longer the trend, the more significant the break.”
This was a nearly three-year trend that failed last month. We are now seeing sellers emerge where buyers previously existed.
A broken support line inherently implies that the previous series of buyers who emerged on the trend are no longer present. This is, at the very least, the process by which a market begins to lose momentum.
Further Losses Ahead in Stocks
In the majority of cases, significant multi-year trend breaks will not result in only a single decline as we have seen in October. A larger correction is expected given the magnitude of the trend break.
Our assessment is that the broken 2016 – 2018 rising trend will continue to act as resistance, a range which as of this week constitutes 2785 – 2835. Following a failed attempt to recapture the former trend, stocks should make a new low below the October bottom of 2603. The highest probability continues to be that stocks will decline at least toward the 2335 – 2505 range, which encompasses the longer-term (magenta color) 2009 – present trend line, as well as both the 50% and 38.2% Fibonacci retracements of the entire 2016 – 2018 advance.
From present levels, such would equate to a 10% – 16% further decline in US stocks as initial targets.
Takeaway on Deflationary Event
This pending decline will be a primary manifestation of the deflationary wave we see ahead.
Let us remember: we live in unprecedented times. The President has actively called the Fed “crazy” in recent weeks, a big “no-no” for previous administrations. Yet interest rates remain at generationally-low levels, since the Fed operates independently from the government.
It appears that a showdown between Trump and the Fed is on tap for the next few months. Especially if the Fed tries to hike rates in December amidst a falling stock market.
Precious metals, and gold predominantly, should receive a safe-haven bid during a deflationary bout.
CHRISTOPHER AARON
BULLION EXCHANGES MARKET ANALYST
Christopher Aaron has been trading in the commodity and financial markets since the early 2000’s. He began his career as an intelligence analyst for the Central Intelligence Agency.
Christopher Aaron specializes in the creation and interpretation of pattern-of-life mapping in Afghanistan and Iraq. His strategy has helped his clients to identify both long-term market cycles and short-term opportunities for profit.
