The rally paused yesterday as the S&P 500 pulled back. The reason for the pullback could be due to the high oil price and rising bond yields. Trump said he wants a lower oil price and he has a good reason, high oil prices fuel inflation.
Recently we have seen rising inflation in emerging markets could this inflation spreads to the US and Europe? Possibly because the latest UK CPI was much higher than analysts expected and yesterday ECB president Draghi predicted 'vigorous pickup in core inflaton'. The euro jumped as a result.
The rise in US 10Y bond yields could signal rising inflation in the US. Bond yields are at the highest level this year, a push higher would be negative for the stock market. I have been saying for a while that inflation will rise sharply mainly because there is too much money in the world.
Some of the money was invested, for example if the money is invested in stocks or real estate this money is not part of the money supply. But when asset prices fall investors will sell their assets and the proceeds will increase the money supply. This increase in the money supply creates inflation. You will note that countries with falling asset prices like Nigeria have high inflation.
The trade war will push prices up so may be people are focussing more on the effect of a trade war on prices. This is why bond yields are rising to 3.1%. I see higher bond yields, may be 4% or 5% this will be bad news for the stock market. I think the problem with rising inflation is that it erodes the income from the bond, if you get 3% income but inflation is 3%, in real term you don’t make anything. So bond yields must rise to 4% or 5% and if inflation continue to rise yields will rise further.
This is why upside is limited in the S&P. The main reason why the S&P is rising is because most investors are oblivious to what is happening. They believe Trump, they believe he will make America great again because since he came to power, unemployment is down and GDP is up. He is doing something right now but the future looks bleak.
Meanwhile investors like Trump, the S&P is at all-time high and in this situation you want to be long S&P. You want to be long S&P until the moment investors realise what is going on. When they realise GDP is not going up anymore, unemployment starts to rise, inflation is out of control, bond yields are too high, they will get out. You want to be short at this moment. Of course it is always difficult to know when investors will know.
This is why the Elliott wave pattern give us an advantage, we can be positioned for the turn after the completion of five waves up. Sometimes it is not always clear on the pattern but at least we can step aside and wait. Like the current pattern can be interpreted in two ways. I suspect the S&P will rally further for a week or two before see the top. This will push the FTSE 100 higher above 7500. If we assume the FTSE is in a second wave, this move will end near 7540, assuming the exchange rate GBP/USD is stable. For that to happen the S&P must be in an impulse wave up.
