Weekly Preview / February 06
Notable Events on our Weekly Watchlist:
Monday: Lagarde Speech
Earnings: ATVI, IDXX, ON, PINS, SWKS, SPG, TTWO
Tuesday: Powell Speech
Earnings: CMG, ENPH, FTNT, IT, INCY, RCL
Wednesday: Williams & Barr Speech
Earnings: DIS, AVB, CPRI, D, FOXA, ORLY, HOOD, UBER, YUM
Thursday: Jobless Claims
Earnings: PYPL, ABBV, MT, DUK, HLT, LYFT, RL, UAA
Friday: Michigan Consumer Sentiment
Earnings: N/A
ETFs to watch: SPY, XTN, XBI, QQQ
The Bear Market is so 2022…
Last week, we asked the question of weather the equities rally was genuine, or we were dealing with another “head fake” move. We expect to know the definitive answer to this question soon enough (2-3 weeks). Meanwhile, as speculated from a technical point of view, the bulls are clearly in charge. SPY traded the whole week precisely between the levels that we have designated as support and resistance (403 - 417).
As the surge in risk assets took off after Jerome Powell’s speech, equities got significantly overbought and finished the week by dipping. Many single names are trading in a 3-sigma deviation from their moving averages and are ripe for a pullback (profit-taking). Where and how that pullback occurs is key in how we will trade the markets in the following period. Let’s take a look at SPY’s technicals:
SPY Analysis
Dotted lines represent MACD Signal projection and crossover points are marked with yellow circles
With markets currently decently overbought and extended, we expect resistance at 417 to hold for now. On the MACD indicator, we have projected how a potential consolidation pattern might play out. The yellow box in the chart represents the area where such a consolidation will be positive for the market. If SPY can hold the 403 level (and upper trend-line) on a pullback, then the bear market is officially over. The next target would become the 427 R1 level, to the upside.
If weakness in the market takes SPY below the upper trend-line, then the next logical support level would be the 200-day MA, currently at 393. It is, however, a rather flimsy support, and by that time, many trend following systems will have reduced exposure. A break below 393 would clearly put the bear market back in play and re-test the recent lows.
It is crucial that before taking any significant action in our portfolios, we wait and see which of these scenarios develops. We are already allocated mainly to cash and slightly net-long on equity exposure, and for now this seems to be the best allocation. If we have a technical confirmation for the end of the bear market, then we will aggressively add stocks to our portfolio.
Our (Market Internals, Overbought/Oversold) indicator confirms the highly extended nature of the current market environment. This makes us think that before we see anymore sizable gains, a pullback to support is very much in order.
Dollar Transaction Volume is confirming the current bullish price action, surging above recent levels. It is premature to declare an end to the low-volume, high volatility regime that governed 2022, but, for now, this indicator tells us the rally is legit (volume is relatively high, volatility is relatively low).
Powell starts to see disinflation on the horizon
“We can now say, for the first time, that the disinflationary process has started. We can see that.”
This crucial quote comes from Powell’s press conference following last week’s FOMC meeting. Disinflation has begun to manifest in the slowing pace of price increases, as can bee seen on the historical graph below.
The bullish hope is that a deceleration in prices will allow the Fed to stop hiking rates, despite the fact that inflation is currently elevated and above target. This would lead to an economic “soft landing”, where a recession is avoided, despite reduced inflation.
Of course, throughout history, there have NEVER been instances where inflation was running above 5%, with an inverted yield curve, where recession was avoided. If the Fed achieves a “soft landing”, this would be the first one from such high levels.
We are already seeing EPS turning lower from cycle highs. While the point is not to wait until the bottom to invest, it’s mandatory to observe the cycle in fundamentals. Currently, it still seems a bit early to call this the bottom in EPS, especially since inventories are not moving.
Despite the rally in consumer discretionary stocks, reported inventory levels are at record high levels compared to sales (this leads to low inventory turnover or “shift”). In order to clear inventories, companies will need to either cut prices (thus decreasing margins) or simply order less new supply (leading to slowing economic activity).
Running a fundamental based valuation model on a stock like Amazon (AMZN) yields a price target of $105. AMZN traded at $112, before collapsing 8% on Friday to $103.39. Currently, there seems to be more risk than reward in these names.
Takeaway
There are numerous fundamental and historical reasons to be bearish on equities. However, the market has a way of proving most participants wrong. What we are seeing in the technicals is an incipient bull market forming.
A word of warning, regarding January’s best performing stocks, from Morgan Stanley’s research desk:
January has been a month where the laggard’s performance was on fire. Stocks like Carvana (CVNA), Bed Bath & Beyond (BBBY), AMC, Game Stop (GME) have delivered outstanding gains. Meanwhile, stocks like Exxon Mobil (XOM), delivering record revenue and EPS numbers, lagged far behind. If 2023 will turn out to be a repeat of 2001, equities have far more correcting to do.
The Momentum Factor ETF (MTUM), comprised of the market’s leaders, has recorded a negative MTD performance, despite the rally in SPY in the same period. A market that is rising on the back of bankrupt companies does not bode well for a “new bull market”.
Moral of the story: we’ll need to stay nimble in 2023. We need to trade the market that we are getting, not the market we want to see. That is why, for now, we are going to follow our technical models more closely, as they have an edge in these kinds of uncertain times. We will conform to either the bullish or bearish technical outcome, because price carries the most weight under these circumstances.
Andrei Sota