OVERVIEW
Morning Update

• Thursday: The S&P 500 fell 0.58%, Nasdaq 0.65%, Dow 0.60% and Russell 2000 around 1%. It was the fourth consecutive lower session for the S&P 500.

• SPY: Closed at 757.94, almost exactly on its 758.25 50 day average but slightly below it. The 759 to 760 area that had been acting as support has also been lost for now.

• QQQ: Closed at 708.69, roughly 0.3% below its 50 day at 710.61. Nearby support sits around 702.70.

• MDY and IWM: Both broke their recent range floors. MDY closed at 673.39 below 678.60. IWM closed at 287.70 below 289.97, with the small cap decline coming on 1.58x normal volume.

• Breadth: Nine of 11 Swingly sector ETFs declined Thursday. Technology fell 1.41% and Consumer Discretionary 0.44%, while Communication Services was one of the few areas to finish higher.

• Premarket: S&P 500 and Nasdaq futures are both up roughly 0.6% as oil retreats and investors wait for CPI.

• Oil: Brent briefly reached $109.97 overnight before reversing to around $104, while WTI has fallen back below $100. Both are still up more than 8% this week.

• Rates: The 10 year Treasury yield reached 4.979% overnight before easing to around 4.94%. The 30 year touched 5.38% and remains above 5.3%.

• CPI: Consensus is +0.4% month on month and +3.4% year on year for headline inflation. Core CPI is expected at +0.2% month on month and +2.4% year on year.

• Fed: Markets are pricing roughly a 70% chance of a 25 basis point hike next week.

MARKET ANALYSIS
Thursday Was A Very Weak Session

Thursday’s index losses were not especially large, but they pushed several important charts through levels we had been watching all week.

SPY closed at 757.94, QQQ at 708.69, MDY at 673.39 and IWM at 287.70. All four finished lower.

The difference is where they now sit and the SPY and QQQ have only just slipped beneath their 50 day averages. Those breaks are small and neither came with particularly heavy volume.

MDY and IWM are in worse shape. Both were already below their 50 day averages before Thursday and have now also lost the range floors that had been holding the recent pullback together.

IWM deserves the most attention. Its decline came on 1.58 times its 20 day average volume, well above the turnover seen in SPY, QQQ or MDY.

That does not tell us small caps must continue lower today, but it does make Thursday’s break more credible than a quiet move through support would have been.

For the first time in several weeks, none of the four benchmark ETFs can be described as having a completely clean technical setup.

SPY Is Only Marginally Below Trend

SPY’s close at 757.94 left it just a few tenths below both its 50 day average at 758.25 and the recent support area around 759 to 760.

We would not treat that as a decisive breakdown as volume was 1.16 times average, elevated but nowhere near the kind of turnover normally associated with a major distribution event.

The area immediately above current price now becomes the first recovery test.

Getting back through 758 to 760 would put SPY above the 50 day and back inside the prior range. From there, the 20 day average around 765 would be the next useful level.

If SPY cannot recover the 50 day after CPI and instead begins moving further beneath it, the deterioration in MDY, IWM and breadth becomes harder to ignore.

The recent high near 779 is no longer especially relevant to today’s decision.

QQQ Has the Same Immediate Problem

QQQ finished at 708.69, around 0.27% below its 50 day average at 710.61 which is still close enough to describe as a test rather than a meaningful trend break.

Thursday’s decline also came on roughly normal turnover at 1.01 times average and the first level is therefore straightforward as we want to see QQQ back above 710 to 711.

Below current price, 702.70 remains useful support though the wider Nasdaq picture is weaker than QQQ alone suggests. QQQE, which weights Nasdaq 100 constituents equally, is more than 2% below its own 50 day average.

That tells us the average Nasdaq constituent has weakened more than the cap weighted index. We would not use that single comparison to claim a handful of mega caps are carrying the whole market, but the difference fits with the broader deterioration we are seeing elsewhere.

For QQQ itself, a quick recovery above the 50 day after CPI would be enough to improve the picture materially.

Mid Caps Have Broken the Range

MDY closed at 673.39, almost 3% below its 50 day average and beneath the 678.60 floor that had held throughout the recent pullback.

Unlike previous reports where 678 was too far below price to be useful, it matters now because it has actually been broken.

The mitigating factor is volume. MDY traded at just 0.77 times average volume on Thursday. That is not the sort of turnover we would expect if institutions were aggressively exiting mid caps.

We would still like to see 678 to 679 recovered quickly. The 50 day sits much higher around 694, so there is more work required before we would describe the mid cap structure as healthy again.

A quiet rebound back into the old range would be encouraging. Continued trading below 678 would make the break more difficult to dismiss.

Small Caps Are the Weakest Chart

IWM closed at 287.70, below both its recent floor near 289.97 and its 50 day average around 296.50.

The break also came with 1.58x relative volume and small caps therefore have the least room for interpretation among the major benchmark ETFs. Price broke support and sellers were active.

The immediate recovery level is around 290 so if IWM can get back above that area and hold, Thursday’s move could still prove to be a short lived flush. The 50 day near 296 to 297 would come later.

If it remains below 290 while SPY and QQQ also struggle around their averages, we would continue to avoid adding lower cap exposure.

Breadth Has Deteriorated With Price

Thursday’s sector picture was poor with nine of the 11 Swingly sector ETFs declined. Technology lost 1.41%, Consumer Discretionary fell 0.44% and weakness was spread through most of the market. Communication Services gained 0.60%.

The short term McClellan readings also moved further negative across all four benchmark universes.

We would not make a market call from those oscillator values alone, but they agree with what we can already see in the price action.

SPY and QQQ are sitting around their 50 day averages, MDY and IWM have broken support, equal weight Nasdaq is further below trend, and most sectors were lower.

This is no longer a situation where poor breadth can easily be dismissed as rotation underneath strong indexes.

It is broad enough to warrant reduced exposure until some of those measures begin improving.

PPI Was Firm Enough to Keep the Fed in Play

Thursday’s producer price report did not provide much relief and we saw headline PPI rose 0.4% in August, in line with consensus, but the annual rate accelerated to 5.4% from 4.8% and came in slightly above expectations. Energy prices jumped 4.2%, while several categories that feed into the Fed’s preferred PCE inflation measure were also firm.

Initial jobless claims fell to 206,000, another indication that the labour market remains reasonably resilient.

That combination helped drive another increase in Treasury yields and pushed the market’s probability of a September Fed hike toward 70%.

The important nuance is that much of the headline producer inflation is being driven by energy.

Core consumer inflation has been behaving better, which is why this morning’s CPI breakdown matters more than the headline number alone.

If core remains around the expected 0.2% monthly pace, the Fed has more room to argue that the energy shock should not dictate policy by itself.

A stronger core reading would make that argument much harder.

Oil Has Finally Pulled Back

Crude provided some relief this morning after another extraordinary session on Thursday.

Brent gained more than 6% yesterday, settling at $107.63, while WTI finished at $102.48.

Brent then traded as high as $109.97 overnight. Prices have since reversed sharply. Brent is around $104.18 and WTI near $99.52 as Middle Eastern governments reportedly work on a temporary agreement with Iran covering shipping through the Strait of Hormuz.

That is welcome, but it does not resolve the supply problem. Saudi output fell to around 6 million barrels per day in August, the lowest in more than 30 years, after attacks on energy infrastructure. Hormuz traffic remains heavily restricted and Houthi forces have moved closer to controlling another strategically important route through Bab el Mandeb.

U.S. diesel prices have also moved above $6 per gallon for the first time, which matters well beyond the energy sector because diesel feeds directly into transport and distribution costs.

The direction this morning is helpful for equities. The absolute level is still high enough to keep inflation pressure in the system.

The 10 Year Is Still Flirting With 5%

The U.S. 10 year Treasury yield reached 4.979% overnight, its highest in almost three years, before easing back toward 4.94% as oil fell.

The 30 year reached 5.3836%, another multi decade high and the bond selloff has now become global.

Average G7 10 year yields have risen roughly 19 basis points this week, while shorter dated yields have climbed even more as markets price additional tightening from several central banks.

For equities, the issue with 5% is not that something automatically breaks the moment the 10 year crosses it.

The problem is competition. At yields around these levels, investors can earn a substantial return in government bonds without taking equity risk. Financing costs also rise across mortgages, corporate debt and consumer credit.

That becomes particularly uncomfortable when earnings multiples remain high. The move back to 4.94% this morning helps, but the bond market has not yet given equities much breathing room.

Oracle Gives AI Another Strong Read

Oracle is one of the better pieces of company news this morning. Shares are up around 5.5% premarket after the company reported stronger results and another substantial increase in AI cloud bookings.

Oracle signed more than $30 billion of new AI cloud contracts during the quarter, taking its remaining performance obligations to $664 billion, ahead of the roughly $640 billion analysts expected.

That helps address one of the concerns that has followed Oracle throughout the year.

Investors have not questioned whether the company can find demand. The harder issue has been whether it can build enough data centre capacity, turn the backlog into revenue and generate adequate cash flow while spending heavily.

The new bookings and improving execution are encouraging on that front. Adobe is moving the other way after its own report, with shares lower premarket despite beating quarterly estimates. Concerns around the company’s freemium strategy and AI competition remain difficult for investors to look through.

The contrast is familiar by now. AI infrastructure companies continue to show very strong demand, while established software businesses still have to prove how much of that spending ultimately benefits their economics.

CPI Is the Only Thing That Matters Before the Open

August CPI is due at 8:30 a.m. ET. Reuters’ economist survey has headline inflation rising 0.4% month on month and 3.4% year on year. Core CPI is expected to increase 0.2% on the month and 2.4% from a year earlier.

The headline number is likely to be heavily influenced by gasoline. Average U.S. gasoline prices increased to $4.192 per gallon in August from $4.064 in July.

The core number is probably more important for next week’s Fed decision. A 0.2% monthly core print would be consistent with continued moderation in underlying inflation and give policymakers some room to look through part of the energy shock.

A materially stronger core number would come at an awkward time. Payrolls were strong, producer inflation was firm, oil remains above $100 and markets are already pricing roughly a 70% probability of a rate increase next week.

The market reaction will probably come through Treasuries first, with the 10 year already close to 5%, even a relatively small surprise could produce a larger move than usual.