Weekly Preview / December 05
Notable Events on our Weekly Watchlist:
Monday: ISM Non Manufacturing PMI
Earnings: N/A
Tuesday: N/A
Earnings: SFIX, AZO, MDB
Wednesday: N/A
Earnings: BF.B, LOVE, THO, GME
Thursday: Jobless Claims
Earnings: AVGO, CHWY, DOCU, LULU, FIZZ, RH
Friday: Michigan Consumer Sentiment
Earnings: N/A
ETFs to watch: SPY, IVW, TLT
Technicals improve while fundamentals don’t - the market at a crossroads
Last week saw most asset class markets scream higher on Wednesday, following Powell’s press conference. The S&P500 traded above the 200-day Moving Average, and a lot of investors started speculating on weather a bull market is starting yet again. Various calls of upside to $440-$450 by year end for SPY started to circulate on social media. Then Friday’s jobs report hit the wires which caused an immediate bearish reaction in the futures market (ES -1.6%) - the reality of sticky inflation started to cause concerns amid a hot and still tight labour market.
Friday’s trading session must have crushed bearish sentiment however, since the losses at the open failed to materialize at the end. SPY finished lower by just -0.12%, and recuperated almost all of the losses throughout the day. One could see this as a successful test of the 200-day Moving Average, a bullish development. In the grand scheme of things, the 200-day MA seems to be just noise at the moment, since the most important technical levels are still quite wide apart, with the market trading sideways between them.
SPY Analysis
The short-term MACD indicator is still positive, after almost registering a SELL signal. Remember: in order for the MACD to signal the next BUY, a SELL signal must occur first, by the way of a negative crossover. The behaviour of this indicator is suggestive of a “bear market rally” at the moment, as momentum has not waned, despite a couple of weak sessions.
I would also like to point out the very weak slope of the technical trading channel for SPY. It is now almost flat (just 0.24% CAGR, if viewed on our Technical Analysis Instrument, from 0.94% last week). A flattening technical channel, which will soon turn negative absent a major positive catalyst in prices, is indicative of a developing bear market. A negative slope for SPY will also have major implications for the asset allocation of our automated strategies. The market MUST rally convincingly in order to reverse this process.
The surge in transaction volumes from last week (Market Internals / Volume) has failed to reverse the recent downtrend, as the Fed is still removing liquidity from the system. Moreover, we are still firmly entrenched in a high realized volatility regime, relative to the recent past (lower panel). Ideally, at the onset of a bull market, we would like to see higher than normal volume on low realized volatility, in a “boring” market (smart money accumulation).
The market is anything but “boring” at the moment, with many traders still chasing this rally and clinging to the hopes of a Fed pivot and untold riches at the end of the investing rainbow. More on this later.
30-day options implied volatility for SPY has been crushed along with bearish sentiment. The VIX index, which measures volatility expectations (also known as “the fear gauge”) has been pushed below 20. Recently, such readings have denoted excellent moments to hedge and reduce exposure (previous sub-20 readings have been recorded in April and August).
New bull markets don’t usually start with volatility expectations this low.
The exuberant sentiment can also be measured with our Market Internals Overbought / Oversold indicator, currently at an extreme high reading. Again, this is hardly the environment that one could find at the start of a new bull market.
It bears mentioning, however, that the 2-stdev Stocks Overbought line is nearing the 2-stdev Stocks Oversold (the lines are almost overlapping in the lower panel). Such a close reading aligns with the view of a market in balance, for the moment, with the slight advantage to the bears. However, this is a development that we are watching closely.
Would a Fed pivot really be bullish for stocks?
Let’s turn our attention to the Powell’s statement, which was correctly interpreted by the market as being “less hawkish'“ than last month. Take the two most important excerpts of the speech:
“1. “The time for moderating hike pace may come as soon as December.”
2. “I don’t want to overtighten. Cutting rates is not something we want to do soon. So that’s why we’re slowing down, and we will try to find our way to what that right level is.””
Just last month, Powell was saying (more confidently): “If we overtighten, we can support economic activity.” So we need to ask ourselves - what made the Fed Chair go from being fine with overtightening, to being more cautious of doing so? One one hand, logic states that the Central Bank cannot continue rising rates at a 75bps rate at every meeting. At some point, they will need to slow down.
What usually makes the Fed reverse course and aim for monetary accommodation is the combatting of a recession, bear market or unstable financial conditions. These are not instances when holding risk assets in a portfolio would make much sense.
Powell must have noticed the cracks in the employment reports (ADP showing 100,000 manufacturing jobs lost) and multiple manufacturing gauges slipping into recessionary territory. Pending Home Sales are down -37% from a year ago, a clear warning sign from the housing market. Bonds must have also figured this out, since treasuries at the long end of the curve are ripping higher.
If there is one asset class to be holding long while the Fed is performing a pivot, it is certainly bonds, not stocks. Currently, TLT is extremely overbought, but we believe this is the rally to chase into 2023. Bonds would be the clear beneficiaries of money inflows in the event of a recession, both as a safe haven play as well as a target for a new QE program.
Higher for longer?
There’s also the question of how long the Fed will keep interest rates high for. Currently, futures contracts tied to U.S. short term-rates reflect bets that the Fed would continue raising rates next year, up to around 5% by May.
The same contracts for just a couple of months later see the Fed lowering rates into year-end 2023, at 4.5%. The pivot will happen somewhere in Q2-Q3 2023, when a recession is expected to hit.
Takeaway
The current action in the stock market is still looking like a bear-market rally. With sentiment at all time highs for equity bulls, such is not a time to initiate long positions simply by chasing momentum. An opening could emerge for a trade if profit-taking starts to appear, pushing the market lower without breaking support. There is still consolidation work to be done in the meantime.
If there’s any chasing to be done, we would be much more inclined to do so in the treasury market. Both fundamentals and technicals are much more likely to align for bonds. This asset class that would provide safety in the event of a recession (generate guaranteed yield) and good supply-demand dynamics on the technical side. While too hot to touch for the moment, the plan is to buy the dip here.
Andrei Sota