Stalling the Plane

As a young child, my father bought several airplanes to lease out to the flight school at the old Freeway Airport in Tucson, Arizona. When you are a kid, flying in your own small plane can be quite a thrill – except when a commercial jet is landing behind you.

Freeway Airport Circa 1966, Tucson, Arizona

Of all his planes, my favorite was a “V” tailed Beechcraft Bonanza. Again, when you are only 8-years-old, the “V” tail is cool – and different from the other planes. Always the curious cat, I wanted to know how this worked and why it was different. In fact, I wanted to know everything about the plane, flying, etc., and my father often gave me the steering wheel to fly. It was not as easy as it looked, and I had to learn to give it a light touch. Just like the markets, it is easy to oversteer.

Beechcraft Bonanza “V” Tail

I enjoyed flying but never pursued it as an adult. Let’s say I know myself too well. I am an absent-minded professor. I spend too much time in my head. Indeed, I would be the one you read about in the papers who forgot to put the gear down before landing the plane.

Instrument Panel

I often say that flying an airplane on instruments is one of the best analogies I know to the skills necessary to successfully navigate the markets. You learn to trust your instruments. When flying In bad weather, you cannot always see the ground. Many a plane has been plowed into the side of a hill when a pilot trusted her “gut” instead of her instruments. We did not have GPS in those days.

When my father used to let me fly the plane, he often told me not to pull back too hard on the wheel. He would explain that if the plane went up too fast at too steep an angle, it would stall. After a stall. and absent the skills of an experienced pilot, the plane could end up spiraling straight down.

I have applied this aerodynamics lesson many times to the markets – as the principle is much the same. As an example, take a look at the chart of the NASDAQ 100 below from the start of this bull market in 2009:

NASDAQ 100 Index – 2009 to Date

If that were the flight path of an airplane on a radar screen, guess what happens next? There are no guarantees in navigating the markets, but I consider myself a skilled pilot. And even if I landed the plane we find ourselves in now with the gear up, it would still be a lot better than trying to pull the plane out of a spiral after the stall.

So if I seem a bit cautious of late, hopefully, you can see that there is a method to my madness. There is nothing normal about the current situation – and we are living on borrowed time. At some point, we will have to pay the piper. Incidentally, the Piper Comanche was my second favorite plane. I wonder if the social justice warriors will require a name change?

Today's Plan

The liquidation break I had been expecting the last few days finally came and went yesterday. It was a 40-point air pocket in the S&P 500 futures – not a pleasant ride unless you are short. Interestingly, the market tested above Tuesday’s high and then below last Thursday and Friday’s lows – but landed smack dab in the middle by the close.

Chart Below is a Carve Out from First Chart Above (The dark blue candle is yesterday and the light blue candle that follows is the overnight action so far today):

As I have often communicated, liquidation breaks strengthen the market, as the poorly positioned longs and weak hands are eradicated, at least in the short-term. But the exploration above and below recent highs and lows typically gives us scant clues about what the market wants to do next. This morning’s level is not a great position to establish longs either, unless you are willing to be super attentive.

Moreover, this particular leg of the rally rose on diminishing volume, except for yesterday.

Chart Below is a Carve out from First Chart Above (Note the diminishing volume on each daily candle until yesterday, when volume spiked):

So, as Joe Biden’s new press secretary often drones, “circling back” to my airplane analogy, the volume spike on the outside day yesterday is another sign of “stalling.” We often see this kind of candle behavior and volume spike near short-term peaks and troughs.

Having said that, the red line on the charts is the 5-day Exponential Moving Average, and it is providing support for now. That will be a key line in the sand if you are still in the markets. As has been the case recently, we handed the ball to the bears yesterday and overnight, but they keep fumbling. The bulls have the ball for now.

We grabbed some timely profits yesterday on half of our XLF and XLE positions. So we still have a small exposure to the markets (a leveraged 3% in calls).

The trigger for consternation yesterday may have been the inflation numbers. Both the consumer and wholesale inflation numbers were tame and less than consensus estimates. We will be tracking these numbers closely for the foreseeable future as the deflation/inflation debate is a key theme for our near-term sector allocations.

Consumer Price Index

The US’s annual inflation rate was steady at 1.4% in January, the same as in December, and slightly below market forecasts of 1.5%. From an annual perspective, central upward pressure came from food prices (3.8%), used cars and trucks (10%), utility gas service (4.3%), medical care services (2.9%), shelter (1.6%), electricity (1.5%) and new vehicles (1.4%). Meanwhile, apparel prices fell 2.5%, and energy costs went down 3.6%, mainly due to gasoline (-8.6%).

On a monthly basis, consumer prices went up 0.3%, in line with forecasts and following a downwardly revised 0.2% rise in December driven by a 7.4% rise in gasoline cost. The indexes for electricity and natural gas declined, but the energy index rose 3.5%. Food prices rose slightly by 0.1% as an advance in the index for food away from home more than offset a decline in the index for food at home.

With deflation still a considerable risk in a potential collapse of the gargantuan debt bubble at hand, markets would like to see inflation pick up. Given the rise in oil and commodity prices of late, I don’t think the financial markets will be disappointed with the February numbers published in March.

As price value and the settlement on the S&P 500 futures contract have been virtually unchanged for the last three sessions, there is little impetus to react strongly one way or the other at the open. I will trade from the basic framework that while the market is still overbought in the short term, there has been some corrective activity (a liquidation break) that might strengthen it as it goes. I am cautiously bullish unless price finds acceptance in the lower single prints, paying close attention to where value develops.

My approach always is to follow the market as it tests the overnight highs and lows and yesterday’s highs and lows to see where it grips. References above are yesterday’s high (also the all-time high) of 3928.50, settlement over the last three sessions at 3908.75, the top of the single prints at 3889.75, and yesterday’s low (also the bottom of the single prints) at 3878.50. The references to untouched POC’s and the top of Gap in the previous two morning outlooks should also be carried forward.

The bulls still have the ball, and my best guess is that they have one more small push to the top channel line visible in the first chart above before the mid-month cycle low draws us down.

A.F. Thornton