U.S. small cap stocks may be signalling market bottom

By Caroline Valetkevitch and Chuck Mikolajczak

NEW YORK (Reuters) – As the small cap Russell 2000 hovers near bear market territory, some strategists are optimistic the index and U.S. stock market may be close to a bottom for the recent sell-off.

The Russell index of small capitalization stocks, often the most volatile of the major U.S. stock indexes, has led the way down in the recent market selloff. The index has been in an almost steady decline since hitting a record closing high on Nov. 8, while the S&P 500 last hit a record high close on Jan. 3.

As of Tuesday’s close, the Russell was down 18% from its record close, and the S&P 500 is off about 9% from its closing all-time high. A close of 20% or more below a record high close confirms an index is in a bear market, while a close of 10% below a record confirms a correction, according to a widely used definition.

“It’s been a bloodbath for small caps,” said Steven DeSanctis, a small and mid-cap equity strategist at Jefferies. “The average small cap stock is down about 40% from its 52-week high.”

While the market’s lows may not yet be in, “this is part of the bottoming-out process,” he said, and small caps are “kind of the canary in the coal mine.”

One year performance of Russell 2000 vs S&P 500 https://fingfx.thomsonreuters.com/gfx/mkt/egpbkjzgkvq/Pasted%20image%201643144121022.png

Stocks were bouncing in early trading Wednesday. To be sure, with ongoing rate hike worries and fourth-quarter earnings season still in full swing, many investors remain cautious that the sell-off has further to go.

Investors have been spooked in recent months by spiking inflation and growing expectations the U.S. Federal Reserve will tighten monetary policy even more aggressively than the market has been bracing for.

The Fed is due to release a statement later Wednesday following its two-day policy meeting, and Fed Chair Jerome Powell will hold a news conference. Adding to this week’s tensions, NATO put forces on standby and the United States put troops on heightened alert in response to a buildup of Russian forces along Ukraine’s border.

Because they are more volatile than large caps, small caps often see bigger swings during periods of strong up moves and also in fast market downswings.

With the Russell, investors seem to be pricing in a recession, but that’s not likely to happen, DeSanctis said. For these stocks, “valuations are getting a lot cheaper. Earnings are holding up. I can’t see it getting a lot worse from where we are today,” he said.

In intraday trading Monday, the Russell fell below the critical 20% level from its November record closing high, before a late-day reversal helped the index to close up 2.3% on the day. It has yet to end 20% below its closing record.

Some strategists said hitting those low levels early in the session – especially in the Russell 2000 – may have triggered some buy signals.

“There’s still a lot of cash on the sidelines, so people with cash are especially attuned to a time period like this,” said Jake Dollarhide, chief executive officer of Longbow Asset Management in Tulsa, Oklahoma. The move in the Russell 2000, he said, “might have been a bigger indicator than anything.”

Small caps may be looking especially attractive as prices have fallen.

The forward price-to-earnings ratio for the Russell 2000 is now at 22.1, down from 28.1 in early November, according to Refinitiv data. By comparison, the S&P 500’s forward P/E ratio of 19.7 is down slightly from 21.8 in the beginning of November.

Russell 2000 Forward PE https://fingfx.thomsonreuters.com/gfx/mkt/jnvwelgxrvw/Pasted%20image%201643207575894.png

Jill Carey Hall, equity & quant strategist at BofA Securities in New York, wrote in a note this week that with the Russell 2000’s big drop from its November highs, “most of the worst could be behind us,” and says investors should “stick with small.”

(Reporting by Caroline Valetkevitch; Editing by Alden Bentley and Chizu Nomiyama)

Analysis-Investors worry about hawkish Fed hurting growth, even theorize over next recession

By Davide Barbuscia

NEW YORK (Reuters) – Laser-focused on how aggressive the Federal Reserve will be in tightening policy, some U.S. investors and strategists are starting to worry about what may seem a distant threat: a sharp economic slowdown or even the next recession.

Investors have been unnerved in recent days about the potential for a more hawkish Fed than previously expected. Some are concerned an aggressive interest-rate-hiking cycle, combined with a reversal of the U.S. central bank’s bond-buying program, could cause too sharp a slowdown.

A hawkish stance by the Fed, which concludes its latest two-day policy meeting on Wednesday, has pushed up short-term rates, flattening the closely followed yield curve on U.S. Treasuries.

“I am intently focused on the yield curve,” said Matthew Nest, global head of active fixed income at State Street Global Advisors. “The only way the Fed can bring down inflation is to slow demand, … and in doing so it risks causing a recession or a sharp slowdown in growth. This dynamic is causing the yield curve to flatten and increasing strain in risk markets more broadly.”

The yield curve between 2-year and 10-year notes flattened to less than 75 basis points on Tuesday, the smallest gap since Dec. 28.

U.S. benchmark 10-year yields retrenched this week as stocks tumbled, which was partly seen as a flight to safety but gave a measure of the delicate tightrope the Fed faces as it plans to start draining pandemic stimulus liquidity from the markets to fight surging inflation.

“The markets seem to be pricing concern about a localized, relatively short-term inflationary problem that results in Fed action that is ultimately damaging to the economy,” said Michael de Pass, global head of U.S. government bond trading at Citadel Securities.

David Kelly, chief global strategist for J.P. Morgan Asset Management, said last week in a research note that Fed tightening could lead to a correction in financial markets, though he said if this were to result in a U.S. recession it would be “shallow and short-lived.”

The fears may seem distant as the economy has been regaining speed. According to a Reuters survey of economists, growth in 2021 could come in at 5.6%, which would be the fastest since 1984. The economy contracted 3.4% in 2020.

Gary Black, manager of the Future Fund Active ETF, said while just four to six weeks ago people “were worrying about too much growth,” they are now “worried that they’re nearing the R word,” pointing to the move in the small-cap Russell 2000 index, which fell more than 20% from its record closing high on Nov. 8, before it reversed to move higher.

“That’s the schizophrenic nature of this market,” said Black.

Tobias Adrian, director of the International Monetary Fund’s Monetary and Capital Markets Department, said while there was some talk in the market about recession due to the yield curve’s flattening, it was not expected.

“We are expecting growth continues, slowing in coming years but positive,” Adrian said. The IMF on Tuesday lowered its economic forecasts for the United States, China and the global economy.

NORMALIZATION?

Larry Fink, chief executive of BlackRock, the world’s largest money manager, warned last week of the risk of a possible curve inversion in case of a fast pace of monetary policy adjustment by the Fed to curb inflation.

The last time the yield curve went negative, which historically has been an indicator that a recession will follow in one to two years, was in 2019. The coronavirus-driven U.S. recession lasted only two months, ending with a low point in April 2020.

Still, some investors said the rally in U.S. Treasuries over the past few days was a normalization after yields spiked too quickly since the beginning of the year, and that economic data do not point to an impending risk of recession.

“The market got ahead of itself and started pricing in a very aggressive Fed, and the curve flattened out a lot sooner than it would in prior cycles,” said Subadra Rajappa, head of U.S. interest rate strategy at Societe Generale.

For Guneet Dhingra, head of U.S. interest rate strategy at Morgan Stanley, the curve flattening has been exacerbated by demand from pension funds on the back end of the curve.

“I don’t worry about the recession fear, based on the recent curve flattening. I do think it’s more a function of technicals than fundamentals,” he said.

(Reporting by Davide Barbuscia; additional reporting by Bansari Mayur Kamdar and Megan Davies; editing by Megan Davies and Leslie Adler)

S&P 500 eyes first correction since 2020 pandemic collapse

By Caroline Valetkevitch and Noel Randewich

NEW YORK/ SAN FRANCISCO (Reuters) – The S&P 500’s early tumble on Monday put the world’s most-followed stock index within reach of confirming its first correction since the 2020 collapse in global markets brought on by the coronavirus pandemic.

The S&P 500 slumped as much as 4%, slammed by ongoing worries about rising interest rates and geopolitical fears related to Ukraine. The index was more than 10% below its Jan. 3 record high close before bouncing back to end the session with a daily gain of 0.3%.

It is now down 8.1% from its record. A correction would be confirmed if the index closes 10% or more below its record closing level, according to a widely used definition.

(Graphic: Index losses of 10% or more from record highs, https://fingfx.thomsonreuters.com/gfx/mkt/lgpdwjdgjvo/Pasted%20image%201643053005222.png)

Wall Street has reeled in recent months from spiking inflation and growing expectations the U.S. Federal Reserve will tighten monetary policy more quickly than expected. Monday’s early rout stemmed from those concerns, as well as an announcement by NATO that it was putting forces on standby to prepare for a potential Russian incursion into Ukraine.

“Investors have gotten spooked because nobody really knows what (Fed Chairman) Jay Powell will do. Will he hike three times, four times, five times?” said Gary Bradshaw, portfolio manager at Hodges Capital Management in Dallas, Texas.

The Russell 2000 index of small cap stocks <.RUT> was down more than 20% below its November record closing high Monday before reversing course.

The Russell index ended up 2.3% on the day but remains down about 17% from its November record high following several weeks of steady declines. A close of 20% or more below its record closing high would confirm the index is in a bear market.

Hitting those low levels early in the session may have triggered some buy signals, said Jake Dollarhide, chief executive officer of Longbow Asset Management in Tulsa, Oklahoma.

“The small cap Russell 2000 hitting 20% down (from its record) might have been a bigger indicator than anything,” he said.

The Nasdaq last week confirmed its fourth correction since the beginning of the pandemic, and is now down about 14% since its November record closing high.

Rising interest rates tend to disproportionately harm shares of high-growth companies because investors value them based on earnings expected years into the future, and high interest rates erode the value of future earnings more than the value of earnings made in the short term.

The Nasdaq and Russell 2000 have lagged the rest of the market because they have more stocks with higher multiples, said Michael James, managing director of equity trading at Wedbush Securities in Los Angeles.

Steven DeSanctis, equity strategist at Jefferies, wrote in a recent note that small caps “are pricing in a chance of a recession.”

“High-yield spreads have not budged, nor have ’22 earnings estimates, yet relative valuations are as cheap as they were in ’20,” he noted.

Following this month’s decline in the S&P 500, the index is trading at about 21 times expected earnings, still far above its 10-year average of about 17, according to Refinitiv data.

(Graphic: S&P 500 forward P/E is far above its historical average, https://fingfx.thomsonreuters.com/gfx/mkt/lbpgnjkylvq/Pasted%20image%201643052964596.png)

Energy is the only one of 11 S&P 500 sector indexes with a gain year to date, up about 13%. Consumer discretionary <.SPLRCD> and technology <.SPLRCT> have been the worst performers in 2022, both down about 11%.

(Graphic: S&P 500 component performance so far in 2022, https://fingfx.thomsonreuters.com/gfx/mkt/byprjmgnkpe/Pasted%20image%201643052901112.png)

(Reporting by Caroline Valetkevitch and Noel Randewich; Editing by Aurora Ellis and David Gregorio)

Wall Street stocks nosedive, small caps flirt with bear market signal

(Reuters) – The prospect of a Russian attack on Ukraine and worries about the Federal Reserve moving aggressively to tighten policy sent Wall Street into a tailspin on Monday, with the Nasdaq closing in on a line that would signal it has been in a bear market since peaking in November.

A morning skid in the small-cap Russell 2000 index put it down more than 20% from its record closing high on Nov 8, before it reversed to move higher. If ends down 20% on a close to close basis it would meet the official criteria for a bear market. The tech-heavy Nasdaq was down 15.6% from it’s Nov 19 record close, but was briefly 18.5% below it.

The S&P 500 also moved off its lows but was still 9.9% below it’s record close on Jan 3. If it closes 10% below it would mean it has been in a correction since that date.

[.N]

MARKET REACTION:

* STOCKS: Dow down 1.81%, S&P 500 down 1.92%, Nasdaq down 1.73%, Russell 2000 up 0.36%

* BONDS: The yield on benchmark 10-year notes fell to 1.6746 [US/]

* FOREX: The dollar index rose 0.241% [FRX/]

* VIX: The VIX was up 16% and touched its highest level since Oct 2020

COMMENTS:

MEGAN HORNEMAN, DIRECTOR OF PORTFOLIO STRATEGY, VERDENCE CAPITAL ADVISORS, HUNT VALLEY, MD

Investors are accepting the harsh reality that the end of the ultra easy monetary policy is upon us. This week the Federal Reserve meets and while we expect no changes at this meeting, the market is pricing in a full quarter point increase in March.

Tech [is] taking the brunt of weakness: Excess liquidity and ultra easy monetary policy have fueled speculation, euphoria and excessive pricing in some investments. What we have seen is these are the areas of the market getting hampered the most in the recent volatility. Technology, which saw valuations reach dotcom like levels, is down 14% from its high with more than 70% of the stocks in the NASDAQ Index 20% or more below their 52-week high.

KEVIN MAHN, CHIEF INVESTMENT OFFICER, HENNION & WALSH ASSET MANAGEMENT, PARSIPPANY, NEW JERSEY

“Today’s slide is part of the continuation of the market reacting to the more hawkish pivot that the Fed took at the end of 2021. That hawkish pivot kind of met the excessive stock market valuations that we saw due in large part to that record three-year run of the S&P 500, which was the best three-year run for that stock index since 1999. So I think a large portion of this pullback is due to people taking profits, people having concern that the Fed may go too far and perhaps derail this economic recovery.”

MARC CHANDLER, CHIEF MARKET STRATEGIST, BANNOCKBURN GLOBAL FOREX

“Given people have lost money, whether it’s in crypto or the stock market, people want to find a culprit and I think that people are torn between two possible candidates: the Federal Reserve and Russia.

“I’m skeptical that all of this is Russia driven. But it doesn’t mean when the first shots are fired, there won’t be a dramatic market reaction. 

“Gold has rallied but it’s coming off its highs after peaking last Thursday. Oil prices also are reversing. Oil is having what they call an outside down day. It traded on both sides of Friday’s range, and now is below Friday’s low.”

BURNS MCKINNEY, PORTFOLIO MANAGER, NFJ INVESTMENT GROUP, DALLAS

“It seems that we get this every time we go through a Fed tightening cycle, but this just seems more of the same as the stock market is starting to price in the Fed basically concluding its taper and beginning interest rate hikes.”

“You have seen more and more with inflation continuing to prove to be more resilient than had previously been anticipated. Last year, the key word was transitory, transitory, transitory … Everything ends, but I think people weren’t really pricing in inflation being as sticky as it has.”

“Poll numbers have shown that Americans are more concerned about inflation than they are about jobs. You don’t see that very often. As such, the talk has gone from the market pricing in the Fed starting to maybe hike one or two times this year, to hiking three or four times this year, and now it’s looking like it is even pricing in an outside chance of five hikes this year, and there has been some discussion about whether you can have a double boost in March. Each of those steps along the way, the market has kind of pulled back a little bit to price that in.”

DAVID MADDEN, MARKET ANALYST, EQUITI CAPITAL, LONDON

“Traders continue to be in selling mode as fears mount surrounding the Russia-Ukraine situation. Also playing into the mix are the concerns the Federal Reserve will issue a hawkish update on Wednesday. The growing Russian military presence on the Ukrainian border is adding to the speculation there will be an invasion, and those fears have been fueled by the news that UK and US embassy staff in Ukraine have been instructed to leave the country. Dealers are worried about the prospect of a war in Eastern Europe as the human and economic cost would be huge.”

“Its déjà vu in the US as worries about several interest rate hikes from the Fed this year is hammering stocks. The NASDAQ 100 is once again the underperformer of the bunch as its large exposure to the technology sector is acting like a millstone around its neck. The US central bank is due to make their latest interest rate decision on Wednesday, and even though rates are likely to be lifted, the language used will be in focus. Dealers will be trying to decipher the commentary to try and figure out how rate hikes can we expect in 2022.”

PETER CARDILLO, CHIEF MARKET ECONOMIST, SPARTAN CAPITAL SECURITIES, NEW YORK

“In the past half hour, panic selling is moving into the marketplace based on a bad combination of factors. The two factors that are really weighing on investor sentiment are the geopolitical situation as winds of war surface and fears that the Fed up may be overly aggressive this week.”

“Today’s sharp drop is due to the geopolitical reasons because if you look at two markets that are going opposite of the other markets, you have the U.S. dollar which is moving higher and you have yields that are moving lower, so that means people are moving into safety trade.”

(Compiled by the Global Finance & Markets Breaking News team)

Best Stocks, Crypto, and ETFs to Watch – Amazon, IBM, Tesla, Bitcoin in Focus

Amazon.com Inc. (AMZN) fell to support at the September 2020 and March 2021 lows at the close of Friday’s session, raising odds for a breakdown from the 18-month topping pattern. It’s typical for stocks to bounce at least once at a major support level but Netflix Inc. (NFLX) defied that expectation when it ripped through 475 on Friday. Of course, almost anything is possible right now, with the S&P Volatility Index closing in on 30.

International Business Machines Corp. (IBM) reports Q4 2021 results after Monday’s closing bell, with analysts looking for a profit of $3.29 per share on $15.96 billion in revenue. November’s Kyndryl Holdings Inc. (KD) spin-off will skew the results, forcing analysts to look for clues about growth prospects for the new slimmed-down operation. IBM failed another attempt to break a 9-year downtrend earlier this month but the new cloud-focused tech giant could defy the odds and enter a new uptrend.

Bitcoin (BTC) fell within 6,000 points of summer support above 28,000 on Saturday, raising fears the crypto king will complete the next leg of a massive double top pattern. The current downdraft has already crossed the .786 Fibonacci retracement level of the June into November rally, predicting it will eventually complete a 100% retracement into the prior low. A breakdown could have a traumatic effect on new traders who have allowed ideology to overcome risk management.

iShares Russell-2000 Index Fund ETF (IWM) broke down from a 12-month topping pattern last week, dropping below 200 for the first time since the start of 2021. The decline is shocking because January marks the most positive seasonality of the year for the small cap universe. This bearish divergence is sending shock waves through other market capitalization tiers, warning participants that broader averages could head into even deeper corrections.

Tesla Inc. (TSLA) reports Q4 2021 earnings after Wednesday’s closing bell, with analysts expecting a profit of $2.36 per share on $16.65 billion in revenue. The stock has been on a seesaw ride since the Q3 report in October, rallying and reversing above 1,200 three times. The broad pattern isn’t encouraging for long-term bulls, with a potential triple top or channeled correction that could reach 800 before attracting sustained buying interest.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

How To Interpret & Profit From The Risks Of A Depreciation Cycle

Even though these rallies are exciting and profitable when everything seems to be skyrocketing, traders need to continue focusing on the broader market cycles.

The next 5+ years could be very interesting for global traders and investors. Not only are major cycles aligning to present a potentially large global market price rotation, but global central banks have also played a major role in supercharging the speculative bobble phase of nearly all global assets over the past 10+ years. These events are unique because the planet has not seen anything like this in more than 85+ years.

Today, we will explore how these cycles align and how traders should prepare to profit from the potentially broad market cycles over the next 10+ years.

Follow Consumers When Attempting To Understand Market Psychology

Consumer and trader psychology plays a massive role in the speed and amplitude of these major market cycles. Optimism drives significant risk-taking and the desire to share in the profit-taking of major market rallies. Fear and uncertainty usually shock people into a period of inaction—panic and pessimism shift traders into a process of protectionism and a move to safety.

We are currently still in the Euphoria Phase of the market trend. We are starting to see some fear and uncertainty move into trader psychology, but we have not yet seen a roll-over in price to qualify as the Complacency Phase. What this means is that we may still have more opportunities for a continued price rally soon.

I’ve often shared my belief that people need to be keenly aware of their surroundings and what is happening worldwide. Simply paying attention to how friends spend their time and money and how businesses are operating can lead to a better understanding of the local economy. For example, watching to see if commercial properties are suddenly filling with new shops or becoming vacant at a faster pace can tell you quite a bit about the local and regional economy.

Open your eyes and talk to people around your home town. Please pay attention to the global economic factors and ask questions about how people feel or how their business is doing. Sometimes, it is really that simple.

Timeline

Description automatically generated

The 9~10 Year Appreciation/Depreciation Cycle Phase – And The Excess Transition Phase

I remember how the economy shifted before the DOT COM bubble burst and ahead of the 2008-09 housing market crash. Suddenly, the local economy and psychology shifted from optimism into fear, shock, and uncertainty. Many people I talked to were not aware of the broad market cycles that continue to drive market sentiment, but they were aware of the potential crisis that was building around them.

My research into various cycle phases suggests that a 9~10 year Appreciation/Depreciation cycle may be a key factor in understanding various cycle trends and lengths. I’ve also identified an 18 to 30-month transitional phase, which I call the “Excess Phase,” that takes place near the beginning of new Appreciation/Depreciation cycle phases.

The major Appreciation/Depreciation cycle phase usually drives price advance or decline periods. The Excess Phase, the transitional 18 to 30 month period when one cycle ends and another begins, usually reflects a very opportunistic and profitable extreme cycle process. This is often when extreme volatility in market trends can produce very large price trends and sudden price rotations.

Chart, histogram

Description automatically generated

Global Market May Shift Into The Depreciation Cycle Suddenly In The Future

Shortly after the COVID-19 crisis in February 2020, I published an article related to the expectations of a “transitory inflation” trend. My research suggested the US markets would rally after the COVID-19 bottom, then peak and roll over into a diminishing cycle amplitude-phase – possibly lasting many years.

Although my research suggested this peak in cycle amplitude was likely in early 2021, it appears the markets pushed the expansion cycle phase higher throughout most of 2021 and suddenly shifted expectations near the end of 2021. Now, in early 2022, it appears we are shifting direction much faster than many traders expected. Yet, I will warn you that we have not broken into a broad market downtrend at this time. Instead, we still see the initial shift away from the Euphoria phase (possibly).

A picture containing line chart

Description automatically generated

I’ve shared many articles on the shifting global market cycles and how they would create incredible opportunities for traders over the next 10+ years. Let’s take a minute to review one example:

July 29, 2021: THE INADVERTENT DEBT INFLATION TRAP – IS IT TIME TO FACE THE MUSIC?

25+ Months Into An Excess Phase – What Next?

Currently, we’re starting to see some shock in t he markets, with the US major indexes rolling downward after the US Fed indicated tightening and rate increases are likely in 2022. My research suggested the transition from an Appreciation cycle into a Depreciation cycle took place in December 2019 – nearly 25 months ago. Additionally, over the past 25+ months, the market trends have resulted in a massive Excess Phase rally – likely prompted by the COVID crisis and a huge speculative wave by consumers/investors. What next?

At this point, it is a little too early to determine if this is a market peak or if the US markets continue to rally higher – attempting to establish a new higher peak in this Excess Phase Rally. Yet, one thing is certain; we are starting to see some real fear in consumers and traders due to the diminishing expectations related to the US Economic growth rates and the US Fed.

A screenshot of a computer

Description automatically generated with medium confidence

Traders should keep these broad market cycles near the front of their thinking as they attempt to navigate the trends over the next 12+ months. I believe 2022 could see another rally higher, possibly resulting in the SPY moving above $500 before finally reaching a peak price level. After that peak is reached, I believe the US market will roll over into the Complacency phase and transition into the Anxiety/Denial phase fairly quickly.

How To Position Yourself For What May Come

These huge market cycle phases and trends will present incredible opportunities for traders. Learning how to prepare for these big cycle phases and profit from them should be near the top of the list for anyone with money in the markets right now. In my opinion, waiting to prepare for these shifting trends only creates great risks for investors/traders as the Excess Phase Peak appears to be nearing an end.

I invite you to learn more about how my three Technical Trading Strategies can help you protect and grow your wealth in any type of market condition by clicking the following link:   www.TheTechnicalTraders.com

For a look at all of today’s economic events, check out our economic calendar.

Chris Vermeulen
Chief Market Strategist
Founder of TheTechnicalTraders.com

 

Is Stock Market Decline Done for Now?

A decline of -10% or more from the most recent peak is considered a “correction”.

Some Wall Street bulls are noting a decline in bond yields yesterday that they believe indicates the recent selloff may have played itself out. Bears, however, suspect the yield dip is just a blip on the radar with many still predicting 10-year yields will top +2% by the end of the first quarter and perhaps ultimately push towards 2.3% to 2.55 before topping out.

“Bubbles” driven by the Fed’s easy-money policies

The pullback in stock prices has created a more “risk off” mentality that has also bled into other alternative assets like cryptocurrencies that bears believe are massive “bubbles” driven by the Fed’s easy-money policies.

New and ongoing issues that threaten to contribute or extend existing inflationary pressures in 2022 have led to some dramatic recalculations of the Federal Reserve’s upcoming tightening cycle, in turn increasing the downward pressure on more rate-sensitive stocks.

As recently as early-December, most Wall Street insiders were anticipating the Fed would increase rates four times, in increments of 25-basis points. Now, expectations are growing for two hikes of 50-basis points, along with perhaps two hikes of 25-basis points. There has also been some speculation that the initial rate hike, which is expected in March, could be one of the larger 50-basis point moves, an outcome that some worry could send shockwaves through global financial markets.

Another dramatic shift is the expectation that the Fed will begin reducing its nearly $9 trillion balance sheet this year, which Wall Street at one point expected to begin no sooner than 2024.

The Fed meets next week on January 25-26. Ahead of that, investors are anxious to see policy updates from other global central banks, starting today with Bank of Canada, then the European Central Bank on Friday. Bank of Canada is widely expected to hike its benchmark interest rate amid unrelenting inflation similar to what we’ve witnessed in the U.S.

The ECB, on the other hand, is expected to maintain its current policy, with most officials still betting inflation will recede with the pandemic. Unfortunately, current signs point to even higher global energy prices ahead, which will ultimately translate to higher gasoline prices for consumers, as well as higher operating costs for businesses that will also likely get passed along.

Oil prices rose again yesterday after a pipeline explosion that will temporarily halt some exports added to existing disruptions and global supply concerns.

The latest data shows that global oil inventories have continued to shrink into 2022 as several OPEC+ members struggle to meet their production increases.

Data to watch

Today, economic data includes the Philadelphia Fed Index and Existing Home Sales for December. It’s worth noting that December Housing Starts and Permits data released yesterday both came in far above trade expectations.

November numbers were also revised upward. Earnings releases include American Airlines, Baker Hughes, CSX, Netflix, PPG, The Travelers Company, and Union Pacific. Next week we’ll start getting into the big tech giants and other corporate bellwethers like Apple, Boeing, Caterpillar, IBM, McDonalds, Microsoft, Tesla, and Verizon.

Some bullish insiders suspect good results from just a few of America’s leading companies could lure investors back in, possibly setting the stage for a massive rebound, especially if the Fed delivers a less hawkish than expected policy update next week.

On the flip side, many are worried that if Apple, Microsoft, or Tesla were to roll over it could trigger a sizable selloff. I think we are clearly at an inflection point with the Fed changing direction and over 40% of our fund and money managers being too young to ever trade or invest in both a rising rate and rising inflation environment. It will be interesting to see how some chose to navigate these waters.

Earnings Season Brings Worries to Wall Street

What is wrong with the banking sector?

Goldman Sachs yesterday became the latest to fan worries about declining profit margins after the bank reported a +33% jump in compensation which contributed to a -13% decline in Q4 profits.

The escalating costs mirror similar results disclosed by fellow big banks JPMorgan and Citigroup, as well as numerous other companies that have already reported or issued earnings warnings in recent weeks.

Just over 4% of S&P 500 companies have released Q4 earnings, and about 60% of those have cited a negative impact from higher labor costs on current and/or expected future earnings.

10-Year Treasury yield

Stock prices are also facing headwinds from a big jump in bond yields. The 10-Year Treasury yield hit 1.88%, the highest since before the pandemic hit and up from a low of 1.36% in early December.

This is largely a reflection of the U.S. Federal Reserve’s more hawkish monetary policy shift that is widely expected to now bring four or five interest rate hikes in 2022. However, there is a lot of uncertainty surrounding the exact timing and degree of those hikes, with many on Wall Street worried that ongoing labor market tightness, supply chain disruptions, Covid-related shutdowns, and geopolitical tensions will continue to drive costs even higher.

That in turn would likely mean even more aggressive action from the Federal Reserve.

There’s a lot of talk that the 10-Year could eventually push to 2.3% or even 2.5%. the market had to deal with a similar jump in the 10-Year back in 2013 during the “Taper Tantrum” or when the Fed had to start reversing their easing policy that had been associated with the US housing crisis global market meltdown.

If you remember, the stock market went through a fairly rough patch that year as the Fed shifted policy but eventually the market selloff stabilized and stocks rebounded to have a good year. this time around, however, many Wall Street insiders are talking about how the double whammy of escalating costs and higher interest rates is driving a shift away from so-called “momentum” stocks and back toward old school investment fundamentals.

Meaning investors are turning away from hot, trendy stocks that have defied gravity-and lacked profits-in favor of companies with proven track records and good cash flows.

Inflation fears are also once again being exacerbated by the oil market with prices hitting a seven-year high, the highest level since October 2014. The latest jump stems largely from deteriorating relations between fellow OPEC members after Yemen’s Iran-aligned Houthi group attacked the United Arab Emirates overnight on Monday. A Saudi-led coalition retaliated with airstrikes on the Houthi group. The renewed tensions between the UAE and Saudi Arabia raise the risk of more disruptions to the already tight global oil supply outlook.

Data to watch

Today, investors will be digesting Housing Starts and Permits for December, both of which are expected to pull back slightly from last months results.

On the earnings front, today’s highlights include Alcoa, Bank of America, Discover, Fastenal, Kinder Morgan, Morgan Stanley, Procter & Gamble, State Street, United Airlines, United Health, and U.S. Bancorp.

I still think there’s some rough sailing and uncertainty in the waters ahead… Also keep in mind, the Nasdaq 100 is quickly approaching its 200-Day Moving Average. Bulls want to argue that we are going to see a big bounce higher once we test that level. Bears argue that a close below that level could bring on a wave of heavy computer based technical selling. I’m not sure who is going to come out correct but I expect we see some extremes as the battle plays out… stay nimble!

Think About This… Perhaps +40% of fund managers have never traded or invested in a rising rate and rising inflation environment.

For a look at all of today’s economic events, check out our economic calendar.

Fed Ramps Up Hawkish Talk; Tech Sells Off, Dip-buyers Return

Normally FOMC meeting minutes are somewhat of a non-event as the major insights tend to be communicated during the post-meeting press conference. However, this year we’ve had at least two occasions when the release of the minutes has spooked markets into a risk-off mood.

Yields up, stocks down

A combination of soft PMI data, down to 58.7 in December from 61.1 in November, along with a contraction in JOLTS job openings, caused US markets to sell off on Tuesday, January 4. This set the stage for a more pronounced rout on Wednesday when the minutes were released.

image1.png

The bond market sold off, which had the effect of spooking tech stocks, particularly as 10-year yields rose to 1.764% for the first time since March of last year. Crypto also took a significant hit; the broad market was down by around 6% on the day as investors with paper profits from 2021 begin to weigh how slowing growth and a more hawkish Fed are likely to dampen the enthusiasm for risk assets.

The S&P 500 was down over 1.8% on the day. The Nasdaq 100 fell by around 2.7%, and the Russell 2000 dropped by more than 3.3%.

Sector rotation?

A great deal has been made recently about the fact that the percentage of Nasdaq 100 stocks that are down by 50% or more from their 52-week highs is almost at record highs. We haven’t seen a situation when so many of the index’s stocks are down despite it trading close to highs since the dot-com bubble of 2000.

The best performing sectors in the first week of January, following the selloff, were Financials and Energy, up 7% and 4% on the week, respectively. This has caused many to speculate about a broader sector rotation. Whether this proves to be the case or not, you can see the market’s concerns present in this mini rotation. Financials are set to perform well in an environment of rising rates. Also, with inflation concerns still front and centre, and the worst of the winter still not over with, energy seems like a smart bet for many investors.

image2.png

Tech did not actually lead the selloff. Home construction was the worst-performing US sector last week, down 7.8%. Tech was down 3.8% and real estate down 3.3% on the week.

Dip buyers return on Monday

Monday, January 10, saw a substantial gap down across all major US markets on opening. Dip buyers returned en masse to prevent the Nasdaq 100 from enduring a fifth consecutive session of losses. The rally was larger than any such rebound since the depths of the coronavirus crash back in March of 2020. The move would see the Nasdaq 100 alone trading incrementally higher at Monday’s close than it did on Friday’s.

What the minutes said and why it’s a big deal

The offending comments from these particular Fed minutes went as follows:

“…it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated. Some participants also noted that it could be appropriate to begin to reduce the size of the Federal Reserve’s balance sheet relatively soon after beginning to raise the federal funds rate.”

Why was this such a big deal? Because up until now all the talk has been around tapering existing asset purchases and getting to a point where the Federal Reserve can begin to start raising interest rates. These minutes go further than the taper that’s currently underway, or the raising of rates at a faster pace (which the Fed has previously signalled).

December’s minutes suggest that the Federal Reserve is considering putting an end to quantitative easing and replacing it with quantitative tightening (active reduction of the balance sheet). When QE (which is by definition accommodative) goes away, financial conditions necessarily tighten and it’s the prospect of this tightening that financial markets are reacting to.

But it’s more than just that. The famous taper tantrum of 2018 took place as the Federal Reserve was reducing the balance sheet (quantitative tightening) at the same time as raising interest rates. Back then, Powell managed to get the Fed funds rate up to 2.5% before a 20% drawdown in US equity markets caused him to pivot. It’s this combination of balance sheet reduction and interest rate hikes that markets are reacting to.

Data to look out for this week

Wednesday’s upcoming CPI reading should hopefully provide more clarity where inflation is concerned. Also, be sure to keep an eye on the EIA’s crude oil inventory report on the same day, and US initial jobless claims on Thursday.

Final thoughts

The question is how much tightening can equity markets tolerate and where will inflation be once this level is reached? Remember, stocks can rise with a tightening Fed as long as growth levels are maintained. Company earnings will be a key factor to watch this week, as any sharp revisions in growth expectations will get investors’ attention and could result in a further slide for stocks.

Tech, energy and financials stocks, indices such as Nasdaq100 and S&P500, as well as other instruments in forex, commodities and other asset classes are all available to trade with HYCM.

by Giles Coghlan, Chief Currency Analyst, HYCM

Trade with HYCM

About: HYCM is the global brand name of Henyep Capital Markets (UK) Limited, HYCM (Europe) Ltd, Henyep Capital Markets (DIFC) Ltd and HYCM Limited, all individual entities under Henyep Capital Markets Group, a global corporation founded in 1977, operating in Asia, Europe, and the Middle East.

High Risk Investment Warning: Contracts for Difference (‘CFDs’) are complex financial products that are traded on margin. Trading CFDs carries a high degree of risk. It is possible to lose all your capital. These products may not be suitable for everyone and you should ensure that you understand the risks involved. Seek independent expert advice if necessary and speculate only with funds that you can afford to lose. Please think carefully whether such trading suits you, taking into consideration all the relevant circumstances as well as your personal resources. We do not recommend clients posting their entire account balance to meet margin requirements. Clients can minimise their level of exposure by requesting a change in leverage limit. For more information please refer to HYCM’s Risk Disclosure.

US Fed Playing With Fire – Bubbles May Burst While Bond Yields & Metals Rally

As a result, traders quickly attempt to adjust their capital allocation levels as risk assets, technology, and US major indexes roll lower because of expected Fed Rate Hikes and other Hawkish activities.

We will explore how the US Fed’s comments and potential future actions may prompt significant market trends in 2022 and beyond. We’ll also attempt to identify how and when the US Fed may disrupt the US markets. We know the actions of the US Fed will prompt some significant trends over the next 12 to 24 months. We know certain assets will likely rise in value as fear settles into the markets because of rising interest rates and deflating asset bubbles. It is just a matter of understanding how the speculative asset bubble of the past 8+ years and how the US Fed may move to pop these speculative bubbles soon.

Asset Bubbles Everywhere, The Global Markets Continue To Froth

Asset bubbles, such as those created in Cryptos, the US stock market, US Real Estate, and the art/collectible market over the past 5+ years, have visualized the US Fed’s easy money results in terms of bubbles.

Take a look at this chart showing the growth in certain asset classes since the start of 2019. It is incredible to think that these asset classes have rallied so far and so fast in just over 35 months:

  • The Grayscale Bitcoin ETF rallied more than 1200%.
  • The Technology sector rallied more than 200%. Real Estate rallied more than 85%.
  • The S&P 500 rallied more than 94%.

The US Federal Reserve’s move to lower interest rates after the 2018 market collapse, which resulted in a December 24, 2018, Christmas Bottom, prompted an incredible rally phase where traders followed the US Fed in piling into assets. As long as the US Fed continued buying assets and kept interest rates near zero, global traders had no reason to fight the US Fed.

Chart

Description automatically generated

(Source: StockCharts.com)

Is The US Fed About To Pop The Bubble From The Stratosphere?

Our research suggests the US Federal Reserve is changing its policy a little late into the game. However, it appears the US and global markets have already “rolled over” in terms of growth trends and expectations. This SPY to QQQ ratio chart highlights that the US markets entered a peaking phase in late July/August 2020 and reached an ultimate peak in February 2021.

Chart

Description automatically generated

(Source: TradingView.com)

S&P 500 PE Ratio Suggests Investors Are ALL-IN For The Next 90+ Years

In other words, it appears traders have reached their ceiling in terms of what they believe the US Fed is capable of doing at this stage in the rally. For example, the PE Ratio of the US Stock market ending in 2021 ended just below 30, with a historical high for 2021 near 37. The historical mean is 15.96 – which is still relatively high for the US stock market.

Remember, a PE level of 15.96 means any investor buying in at those levels would need a minimum of 15.96 years of a company handing over “every penny of revenue” to the investor (excluding all costs, payrolls, taxes, fees, and other operating expenses) to cover the PE multiple of the investment. So a PE level of 30, as we see at the end of 2021, suggests that stock price valuation levels are at least 60 to 90+ years ahead of real returns.

The only thing that can change this historic level of speculation in the markets is a deleveraging/revaluation event.

Graphical user interface, chart, histogram

Description automatically generated

(Source: multpl.com)

From the US Fed’s Actions To How Traders Should Prepare For Shifting Markets

This first part of our ongoing research into the US Fed’s actions and where they are telegraphing their intents will continue. Part II of this article will investigate how traders should read into these shifting markets and where we’re attempting to highlight what has taken place over the past 3 to 5+ years.

We’ve managed to live through an incredible event in history. I can only think of one other time when a global superpower extended this type of credit and support for the worldwide economy. That was the Roman Empire many thousands of years ago.

What we experience over the next 20 to 40+ years could be the biggest and most incredible opportunity of your lifetime. The process of deleveraging all this debt and working all this capital through the global markets over the next few decades may present one of the most incredible investment/trading opportunities anyone has ever seen in over 1500 years.

Look for my Part II to this article, and we’ll continue exploring the current shifts in the US and global stock and asset markets.

Finding The Right Strategies That Will Help You Navigate Through Bulls & Bears

If you have struggled with finding opportunities over the past year or so and want to know which are the hottest sectors, or how to protect and grow your capital, then please take a minute to review my Total ETF Portfolio – Triple-Strategy Trading Plan to help you profit from these big market transitions.

Learn how I use specific tools to help me understand price cycles, set-ups, and price target levels in various sectors to identify strategic entry and exit points for trades. Over the next 12 to 24+ months, I expect very large price swings in the US stock market and other asset classes across the globe. I believe the markets are starting to transition away from the continued central bank support rally phase and may start a revaluation phase as global traders attempt to identify the next big trends. Precious Metals will likely start to act as a proper hedge as caution and concern start to drive traders/investors into Metals.

I invite you to learn more about how my three Technical Trading Strategies can help you protect and grow your wealth in any type of market condition by clicking the following link:   www.TheTechnicalTraders.com

Chris Vermeulen
Founder and Chief Market Strategist of The Technical Traders Ltd.

 

Is The “don’t fight the Fed” Approach Still Good for Traders?

Just as experienced traders and investors were on board with the Fed easing and propping up the economy, they are now not wanting to stand in the way as the Fed tries to slow things down a bit.

Wall Street insiders are hoping to get more clues as to just how “hawkish” the U.S. central bank might be leaning when Fed Chair Jerome Powell delivers testimony before the Senate Banking Committee today as part of his renomination process.

In very brief pre-prepared comments that were released yesterday, Powell pledged “to prevent higher inflation from becoming entrenched,” but didn’t mention any details in regard to interest rates or the Fed’s asset holdings.

Supply and demand issues

Powell noted that the economy was facing “persistent supply and demand imbalances” as a result of the pandemic reopening. Wall Street veterans are thinking the Fed will make three or four increases this year. Goldman is now forecasting four rate hikes with some insiders thinking five or six rate hikes might now be in the mix, i.e. perhaps a couple of half-point moves in rates might happen rather than the smaller quarter-point bumps.

A growing number also expect that the central bank will begin reducing its $8.8 trillion balance sheet as soon as this summer.

Anticipation of a more hawkish Fed saw 10-year Treasury yields climb to their highest levels of the pandemic last week, though they did ease a bit yesterday. In and of itself, the rise in bond yields is not surprising as investors have been anticipating this would happen in 2022 as the Fed begins lifting interest rates.

However, the climb has started sooner than many expected. The speed at which yields soared last week – +25 basis points – in particular, is tripping up the bulls, with some on Wall Street anticipating the benchmark 10-year could test +2% by the end of the first quarter. Bears are warning that investors may still be underestimating how far the Fed will need to lift its benchmark rate this year to keep inflation under control.

On the other hand, Bulls still expect current higher prices will find relief as supply chain dislocations and labor shortages normalize.

The road to both resolutions is proving longer and more complicated than most hoped, though, with the current Covid wave again threatening global supply chains and sidelining workers.

Transportation in China and US

A suspension of trucking services in several parts of China’s Zhejiang province has slowed the transportation of manufactured goods and commodities through the port of Ningbo, one of the world’s most important ports.

Some Chinese factories have had to stop work due to the trucking snags, too, as they can’t receive raw materials or ship out goods.

U.S. ports on both coasts are also reporting a build-up in ships waiting to unload due to dockworkers calling in sick. Cargo backups are also once again building as transportation and warehousing staff levels suffer.

The only economic data due today is the NFIB Small Business Optimism Index. It’s the Consumer Price Index tomorrow, and the Producer Price Index on Thursday that investors are really anxious to see, with worries growing that big jumps could spur even more hawkish policy moves from the Fed. On the earnings front, Albertsons is the main highlight.

Will 2022~23 Require A Different Strategy For Traders/Investors? Part III

Is The Lazy-Bull Strategy Worth Considering? – Part III

This last part of our multi-part article compares trading styles amidst the increasing price volatility and extended hyperbolic trending. We’ll explore what we’ve witnessed in the US markets over the past 5+ years and highlight what to expect throughout 2022. Additionally, we’ll highlight and feature the strategic advantages of our advanced Lazy-Bull strategies.

Lazy-Bull Rides Big Trends & Avoids Excessive Risks

Many people are inherently opposed to the Lazy-Bull strategy because they’ve been conditioned to think trading requires actively seeking various opportunities every week. We don’t quite see it that way. Instead, we see the opportunity for growth and consistency existing in taking 4 to 12+ strategic trades per year while the markets set up broad momentum moves/trends. Our objective is not to trade excessively just for the sake of trading. Instead, we want to take advantage of when the markets enter opportunistic periods of trending and ride those trends as far as they go.

This example Weekly SPY chart showing our TTI trading strategy highlights the growth phases in various trend stages. Notice the GREEN and RED sections on this chart where our system has identified directional changes in the major price trends. Over the past 11+ years, there have been numerous bullish price trend phases resulting in 12 months to 36+ months bullish price trend trends. These major price cycles make up part of the advantage of the Lazy-Bull strategy.

We are not actively seeking the strongest stock symbols throughout these trends. Instead, we are simply relying on the strength of the US major indexes to carry our trades further into profits as the market’s trend. The TTI strategy is a “set it – and forget it” type of strategy until the strategy generates a new entry or exit trigger.

Chart

Description automatically generated

Volatility & Price Rotation Make 2022 More Dangerous Than 2021 – What Next?

Our research shows 2022 will likely continue to exhibit increased price volatility and bigger price rotation. Meaning 2022 could be very dangerous for shorter-term strategy traders as volatility levels may disrupt traditional stop boundaries or other aspects of their defined strategies.

It is important to understand how and when these issues creep into a strategy and attempt to move above these issues.

Looking at the Q1 through Q4 data using our proprietary Data mining utility, I’ll give you my insight related to the data and what I believe is likely to happen in 2022. Remember, this data consolidated the past 28-29 years of trends in the SPY to present these results – going back to 1993. That means that this data is compiled through several various price trends, major market peaks, major market bottoms, and various volatility levels along the way.

Text, letter

Description automatically generated

Q:2022 Analysis

Q1 data suggests an overall positive/upward price trend is likely in 2022, with the Total Monthly Sum across 29 years totaling 37.94. Broken into annual gains, that translates into an expected $1.30 gain in the SPY in Q1:2022.

The Total Monthly NEG (negative) range appears to be more than double the Total Monthly POS (positive) range. However, we may see some price volatility in Q1:2022 that surprises the markets. For example, maybe the US Fed makes surprise rate increases? Perhaps it relates to some other foreign market event disrupting the US markets? I don’t know what it will be, but I feel some market event in Q1 is likely, and this event may prompt a fairly large downward price rotation in the SPY.

Overall, I believe Q1:2022 will end slightly higher than the end of Q4:2021 levels and may see the SPY attempt to break above $490~500 on stronger earnings and continue the market’s bullish price phase.

Q2:2022 Analysis

The second quarter seems a bit more stable in overall price appreciation trends. The data shows a shallow NEG value compared to a moderately strong POS value for Q2. Because of this, I believe the second quarter of 2022 will slide into a relatively strong upward Melt-Up type of trend after a potentially volatile Q1:2022.

The Total Monthly Sum value is higher in Q2 than in Q1, suggesting Q2 may exhibit a stronger upward momentum as a more apparent trend direction sets up after the Q1 volatility.

The US Fed will likely attempt to aggressively reduce its balance sheet throughout Q2 and into Q3:2022 if my expectations are accurate. This may create some additional market volatility in Q2 and Q3:2022 – but I suspect the US Fed will attempt to conduct a lot of this activity relatively quietly – almost behind the market strength/trends.

Q3:2022 Analysis

Q3 shows data that is somewhat similar to Q1 overall. I interpret this data as showing moderate bullish trend strength within the typical mid-Summer US market stagnation in trend. Mid-Summer trends tend to be a bit more sideways in nature. Many traders are vacationing, enjoying the Summer weather, and/or not paying attention to market trends and dynamics. Because of this, I expect the July through September months of 2022 to be relatively quiet and mundane.

Additionally, we have the mid-term US elections set up in November 2022. The July through September months will be packed with political posturing, campaigning, and various events filled with antics to distract the markets from focusing on real issues. As a result, election years tend to be somewhat quiet – especially in the 2 to 5 months leading up to the actual election date.

The end of Q3:2022 and the start of Q4:2022 could see some bigger, more aggressive price trending. The elections, ramping up of the early holiday/Christmas seasons, and the end of Summer may prompt traders to move into undervalued assets or other opportunist trades seeking to ride out an end-of-year trend. Right now may be a great time to identify strong swing/position trades to close out 2022 with some nice profits.

Q4:2022 Analysis

Q4:2022 shows a very strong bullish trend potential, with the POS results greatly surpassing the NEG results. Historically, this is because of the traditional Santa Rally phase of the US markets and may play a big role in 2022 if the US economy stays strong throughout 2022.

Overall, I expect the US Fed to act in a manner that supports the “transitioning” of the global markets away from excessive risks while attempting to nudge inflationary trends lower. There is talk that the US Fed may take aggressive action to combat inflation, but I see the Fed’s actions are more subtle than brutal at this stage.

I believe the US Federal Reserve is keenly aware of the fragility of the global markets after many years of excessive easy-money policies. In my opinion, the current market environment is more similar to the late 1960s and 1970s than the 1990s and early 2000 time frame. We’ve seen a massive influx of capital in the global markets – push all traditional economic metrics “off the charts” after the COVID event. That capital will work itself throughout the global economy, disrupting more at-risk companies and nations’ capabilities, but still prompt a moderate growth component for many years to come.

Volatility, Trading, And Profiting From Bigger Trends

The entire point was to discuss the opportunities of moving above the current excessive price volatility and adopting a trading strategy that is more suited to bigger, broader market price trends. In 2019, I warned that 2020 was likely to be very volatile.

In February 2021, I warned that 2021 was likely to be very volatile for certain market sectors: WILL 2021 PROMPT A BIG ROTATION IN SECTOR TRENDS? – PART I

In early January 2020, I warned the US markets may be set up for a “Waterfall Selloff”: ARE WE SETTING UP FOR A WATERFALL SELLOFF?

Today, I’m suggesting that price volatility will likely peak sometime in 2022 or 2023 and begin to subside as the excesses of the past 8+ years continue to process through what I’m calling the “transitioning phase” of the markets. This market phase is more of a deleveraging and revaluation phase which started in February 2020 – in various sectors. It has now extended into many global economies where excess risk factors are being addressed and revalued (think China, Asia, and other areas).

This transitioning process will likely continue in 2022 and 2023, meaning traders need to be prepared for the increased price volatility and adopt a style of trading that will allow them to profit from these bigger trends. This is why I’m suggesting taking a higher-level approach to trade over the next 24 to 36+ months.

Certain market trends will still allow traders to pick up some fantastic profits as sectors and various undervalued symbols gain momentum. Overall, though, I feel that 2022 and 2023 will be moderately difficult for shorter-term trading strategies and that a higher-level, longer-term approach may be a much more beneficial approach.

Want To Learn More About My Long-Term Investing Strategy?

My Technical Investor strategy is uniquely suited toward this type of trading style. It is simple, longer-term, and rises above the moderate price volatility that disrupts many shorter-term trading strategies.

A picture containing diagram

Description automatically generated

Get ready; 2022 will be an excellent year for traders with big trends and bigger volatility. We have to stay ahead of these trends to protect our capital and allow it to grow more efficiently. The risks of more traditionally moderate volatility systems getting chewed up in this extreme environment will continue. So be prepared to move towards a more protective trading style to survive the next 12 to 24 months.

If you are interested in learning more about how my Technical Investor (and other trading strategies) can help you protect and grow your wealth in any type of market condition, I invite you to visit  www.TheTechnicalTraders.com

For a look at all of today’s economic events, check out our economic calendar.

Chris Vermeulen

Founder of Technical Traders Ltd.

 

Financial Sector Starts To Rally Towards The $43.60 Upside Target

Near November 24, 2021, I published a research article suggesting the Financial Sector, XLF in particular, may bottom and start to move higher, targeting the $43.60 level. After watching XLF rotate lower and form multiple bottoms near $37.50, it appears to finally be starting a new breakout rally phase ahead of Q4:2021 earnings. Will it rally up to my $43.60 target level before the end of January 2022? And how far could it rally beyond my $43.60 target?

Using a simple Fibonacci Price Extension allowed me to target the $43.60 level. Duplicating that range and applying it to the top of the $43.60 target level will enable me to see a higher target range of $49.55. This upper target level would result from a 200% Fibonacci price rally from the original price range I identified back in late November 2021.

Graphical user interface, chart

Description automatically generated

Could it happen? Sure, it could happen. Financials are uniquely positioned to benefit from higher consumer engagement in almost all levels of the economy. Housing, consumer spending, credit/loan origination, fees and services, trading, and other services – they all combine into Banking and Financial Services. I expect Q4:2021 to show robust consumer engagement and housing data, likely prompting many financial firms’ strong revenues/earnings results.

My original financial sector (xlf) research article included (below) for you to review:

The recent downward price rotation in the Financial Sector (XLF) may have frightened some traders, but my research suggests this move is setting up a future bullish price target near $43.60 – a more than +11% move. The end of the year Christmas Rally phase of the markets should drive spending and Q4:2021 expectations strongly into the first quarter of 2022. Unless something big breaks this market trend, traders should continue to expect a “melt-up” bullish price trend through at least early January 2022.

Sign up for my free trading newsletter so you don’t miss the next opportunity!

The Financial Sector continues to deliver strong earnings and revenue data each quarter. The way consumers and assets prices have reacted after the COVID market collapse says quite a bit about the ability of financial firms to generate future profits. Financial firms actively engage in financial services, traditional banking, real estate, and other investments, and corporate financing. The rising inflation trends and consumer spending activities suggest the US economy is still rallying after the COVID stimulus and recovery.

Financials May Rally 10% to 15%, or more, by January 2022

My analysis of XLF suggests this recent pullback in price may stall and start a new bullish price rally targeting the $43.60 level – a full 100% Fibonacci Price Extension of the last rally in XLF.

This Daily XLF chart shows the extended rally in early 2021 and the brief pause in the price rally between June 2021 and early September 2021. Now that we’ve entered Q4:2021 and the US economy appears to be strengthening in the post-COVID recovery, my expectations are that most sectors, and the US major indexes, will rally throughout the end of 2021 and into early 2022.

This recent pullback in XLF sets up a solid buying opportunity for traders targeting a +10% rally that may last well into January/February 2022 – or longer.

Chart

Description automatically generated

Longer-term Financial Trends Suggest Another Rally Above $44 May Start Soon

Over the past 6+ months, moderate rally phases in XLF have shown a range of about $4.00 to $4.50. I’ve highlighted two recent rally phases in XLF on this longer-term XLF Daily chart below with gold rectangles. I believe the next rally from the recent pullback will be similar in size and prompt a moderate upward price move targeting the $43.60 level – or higher.

Although there are some concerns related to the continuing recovery in the US markets, I believe the momentum of the US recovery and the strength in the US Dollar will push many US sectors higher over the next 60+ days. Closing out Q4:2021 and starting Q1:2022 with a fairly strong rally that may surprise many traders.

The Financial sector is likely to present very strong Q4:2021 revenues and earnings data as long as the global markets don’t push some crisis event or other issue that could detract from the US economic recovery. Right now, the biggest issues seem to be China and Europe.

Chart, histogram

Description automatically generated

Concluding thoughts

My opinion is that any moderate price weakness in the Financial sector will be short-lived and will resolve into a bullish price rally, or “melt-upward” type of trend, as we move into early December 2021. Once the US Debt Ceiling issue is resolved, I believe the Financial sector will begin a very strong rally pushing prices above $44 or $45 as Q4:2021 earnings expectations drive investors’ focus into Technology, Consumer Retail, Financials, and Real Estate.

The strength of the US Dollar is driving large amounts of capital into US assets and stocks right now. Based on my research, it is very likely that the US major indexes and certain sectors will continue to rally into early January 2022. If my analysis proves accurate, we may see a +11% to +18% rally in XLF before the end of January.

If you are interested in learning more about how my strategies can help you protect and grow your wealth in any type of market condition, I invite you to visit www.TheTechnicalTraders.com

Chris Vermeulen

Founder of Technical Traders Ltd.

 

What do FOMC ‘minutes’ Mean for the Stock Market?

When the Fed might begin unloading its bond holdings has fast become a red hot topic. The “minutes” released yesterday from the central bank’s December meeting indicate nearly all members favor starting the balance sheet reduction as soon as this year.

Monetary policy tightening

Investors largely view this sort of action as a form of monetary policy tightening designed to slow the economy and most believed it was still at least a year or even two away.

The Fed is currently on track to stop adding to its nearly $8.2 trillion worth of Treasuries and mortgage-backed securities by mid-March.

For what it’s worth, this is only the second time in its history that the Fed has embarked on an asset purchase “taper” program. After completing the previous (and first) “taper” in 2014, the Fed essentially maintained its balance sheet until 2018, when it began allowing some bonds to roll off. That was ended in 2019 however, when demand for bank reserves outstripped the Fed’s supply, causing volatility in short-term money markets and forcing the Fed to again add to its balance sheet.

Not surprisingly, investors are worried about the Fed once again making a misstep, especially considering that its balance sheet is twice the size it was in 2018.

It’s also worth noting that the Fed hasn’t lifted its benchmark interest rate since 2018.

Interest rates hike

Wall Street currently anticipates anywhere from two to four rate hikes this year, so this is another area where investors worry the central bank could get it wrong. The possibility that they simultaneously attempt to both raise rates and reduce asset holdings means double the chances of missing the mark.

As there is no Fed policy meeting in February, many Wall Street insiders fear that officials could move too aggressively at the upcoming January 25-26 meeting as they face increasing pressures to beat back inflation.

Nothing in recent data provides a reason the Fed might suddenly strike a more dovish tone, either. That includes the job market, which has struggled to return to pre-pandemic levels and which many bulls have hoped might sway the Fed to maintain supports for longer. However, even with nearly 4 million fewer jobs than what the U.S. had in January 2020, the Fed considers the labor market to be mostly healed.

Yesterday, ADP‘s private payroll report showed that employers added almost +900,000 workers in December, which is more than double the +400,000 gain expected from the Labor Department’s official report due on Friday. While the two data sets have diverged greatly in recent months, Friday’s report is still largely expected to exceed expectations.

Today, investors will be digesting the ISM Services Index. Most attention will be focused on the “prices paid” component, which fell slightly in November but was still the third-highest reading ever recorded. Other economic data today include International Trade and Factory Orders. Finally, earnings worth noting include Bed Bath & Beyond, Bridgestone, Conagra, Sanderson Farms, and Walgreens.

2 Stocks From This Defensive Sector Buck The Trend During Market Selloff

After Federal Reserve meeting minutes pointed to a faster-than-expected rise in U.S. interest rates, the 4 major U.S. indices – S&P 500 (SPX), Nasdaq Composite (IXIC), Dow Jones (DJI) and Russell 2000 (RUT) fell significantly. The volatility similar to the Black Friday’s selloff last year is back.

Despite the market selloff, there are still a few dozen stocks showed up in my screener, which is under beta testing. After further filtering based on the price structure and the relative strength, one defensive sector stands out because there are still quite a number of stocks such as Coca-Cola (KO), General Mills (GIS), Tyson Food (TSN), Pepsico (PEP), etc… in a strong up trend and outperform the S&P 500.

Visit TradePrecise.com to get additional market insights and test results from my stock screener in email for free.

The following 2 stocks are selected based on the price volume analysis and could still provide decent reward to risk ratio with a relatively low risk trade entry. Consumer staples is one of the well-known defensive sectors and these 2 stocks are under the Food Products industry group.

Hershey Foods (HSY) Price Volume Analysis

From the weekly chart as shown below, HSY has formed an accumulation range lasted 18 months from September 2019 until March 2021. After breakout from the accumulation structure, HSY had a steady rally and a shallow pullback from July-November 2021.

Since December, HSY broke above the resistance at 180 and continued to trend up despite the increasing volatility showed up in the broad market.

It can be observed that the volume within the accumulation structure has been decreasing, suggested that the supply is exhausted, which is a classical volume pattern based on the Wyckoff method. If you would like to find out more on the application of Wyckoff method, watch the YouTube video to find out how I derive the directional bias for the current market.

On the daily chart below, HSY is on a climatic run with the presence of supply, which could be vulnerable for a pullback. Should a reversal happen near the axis line at 192 where the resistance-turned-support, that could provide a decent entry by leaning on the support level at 192.

Flowers Foods (FLO) Price Volume Analysis

FLO has started an accumulation range from September 2020-2021 (refer to the chart below). After the breakout in October 2021 followed by a shallow pullback tested the resistance-turned-support area at 24.5, the markup phase started. So far, FLO is travelling within an up-channel, forming a higher high and a higher low.

It is worth noting the two volume spikes as highlighted in yellow because those two bars containing increasing of supply, which essentially stopped the short term up move. After the spike of volume in the first bar in mid of November, a pullback took place and tested the demand line of the channel.

After an even higher spike of volume in the second bar in mid of December on the breakout, the pullback is mild and shallow with decreasing volume, suggested the supply showed up on the breakout bar has been absorbed.

In the latest 2 bars, there are presence of supply as reflected in the increasing volume together with the rejection tail and the smaller price spread, which could be vulnerable for a pullback. Watch out for a pullback or consolidation before the next rally. A reversal entry or a breakout entry is viable while leaning the support at 27.5.

As the bias for the short term direction of the market is down plus the deterioration of the market breadth, it is essential to monitor how the price of HSY and FLO reacts and wait for a confirmation before execution.

Will 2022~23 Require A Different Strategy For Traders/Investors?

Is The Lazy-Bull Strategy Worth Considering? – Part I

Many traders struggled in 2021 with the extended price volatility and sideways price trends. Recently, news that Bridgewater’s 2021 results were saved by December’s +7.8% gain (Source: Yahoo! Finance) leads me to believe a number of independent funds and investors are going to have a tough end-of-year return for 2021.

Average Hedge Fund Returns Less Than 25% Of The 2021 S&P500 Gains

The volatility in the US and global markets throughout most of 2021 took a toll on traditional trading strategies. With the VIX trading above 12 on average throughout almost all of 2021, traditional trading strategies may not have been able to adjust to this increased volatility in the US markets – getting chewed up along the way.

I wrote an article series about how computerized trading strategies can fail when volatility levels increase beyond traditional boundaries a few weeks ago. You can read the first of the three part series, US Federal Reserve Actions 1999 to Present – What’s Next?, and then link to the other two.

A screenshot of a computer

Description automatically generated with low confidence

(source: Aurum.com)

Many of the best Hedge Funds could barely squeeze out a profit in 2021. While the S&P500 rallied more than 27% in 2021, you can see from the graphic above that the average returns for Hedge Funds in 2021 were a paltry +6.24%.

I expect that the US and global markets will continue to stay in extended price volatility ranges throughout all of 2022 and into 2023 as broad global market transitioning continues to take place. This expectation leads me to conclude that the “Lazy-Bull” strategy may be better suited for traders/investors over the next 24+ months than more active trading strategies.

What Is The “Lazy-Bull” Strategy?

The Lazy-Bull strategy is a term I use for my proprietary strategies – The Technical Investor and the Technical Index & Bond Trader. I call it the Lazy-Bull strategy because it is straightforward and only generates about 3 to 10 trades per year (on average). Many traders dislike this type of strategy because it it does not require many trades and does not provide the rush/roller coaster ride that many think they should feel while trading, which is not how it should be.

Having said that, overall, this strategy has consistently produced positive annual results (CGAR average ROI 15% – 51% depending on ETF leverage, and only 7 – 21% drawdown) – beating the SPY almost every year. If you traded with the 1x, 2x, or 3x ETFs then you would have crushed the S&P 500 every year, and experienced that positive rush feeling that leverage/volatility provides.

My trading style is a bit different than most other traders. My objectives consist of three very important concepts:

  • Protect Capital At All Times
  • Trade Only When Strategically Opportunistic (probabilities are favorable)
  • Trade Efficiently Using Bonds As Trade When Fear Rises among traders and investors.

Through the Technical Investor and Technical Index and Bond Trading strategies, I help individuals and advisors learn how trading more efficiently using the Lazy-Bull strategies is for generating large compounded returns as shown in the SP500 chart below.

Chart

Description automatically generated with low confidence

I’ll go further into detail regarding my strategies as we continue this multi-part article.

Reading Into Q1:2022 – What To Expect?

Right now, the world is waiting on Q4:2021 earnings and economic data. The first Quarter of 2022 should be very exciting for US traders as the year-end momentum of 2021 may carry forward into Q1:2022 with solid revenues and earnings. After that, we move into Q2:2022, which may be much more volatile overall.

Let’s look at our proprietary data mining utility to see what we might expect from the markets in the first Quarter of 2022.

January 2022 has more than a 1.41:1 probability ratio of staying positive based on the past 29 years of historical data. Ideally, the average positive and negative monthly ranges are about equal – nearly $5.00. The accumulated monthly data shows that January is usually overall positive by at least $2.50 to $5.00.

February 2022 has a much higher chance of extreme volatility. February 2022 shows a much greater positive to negative ratio while the possibility of a bullish February drops to a 1.33:1 probability ratio. Overall, I would suspect larger price volatility in mid to late February 2022 as the markets attempt to transition into late Q1 expectations.

March 2022 has the same 1.41:1 probability ratio as January, yet the overall likelihood of extended downside price trends is about 20% greater than January.

Text

Description automatically generated

My analysis of this data suggests January and March of 2022 may surprise traders with a potential for a significant upward price move headed into Q2:2022. I believe Q4:2021 will also surprise traders as US consumers continue to engage and spend. This will lead to higher expectations for Q1:2022, which may set up a bit of a rally ahead of April/May 2022.

Q1 and Q2, historically, seem to be strong in terms of traditional market growth and expectations. Yes, there have been instances when unexpected volatility disrupts the more customary types of trends – and 2022 may be one of those years. Our research shows the US Fed may make early efforts to move away from extreme easy money policies – which may shock the markets.

Our research suggests the possibility of a 7% to 10% rally in the SPY in the First Quarter of 2022. If our extended research is accurate, our predictive modeling suggests more extreme price volatility may also play a significant role in how price trends/moves in 2022.

Is The Lazy-Bull Strategy Worth Considering?

In Part II of this article, we’ll review the entire year of 2022 Quarterly Data Mining results and present more evidence that 2022 and 2023 may be years where a shift in strategy plays an important role for traders/investors. With the VIX trading above 15 more consistently, many strategies will get chewed up and spit out as the markets roll 9% – 15% up and down while attempting to transition away from the post-COVID stimulus.

Get ready; 2022 will be an excellent year for traders with significant trends and bigger volatility. We just have to stay ahead of these trends to protect our capital and allow it to grow more efficiently. The risks of more traditionally moderate volatility systems getting chewed up in this extreme environment will continue. So be prepared to move towards a more protective trading style to survive the next 12 to 24 months.

Want To Learn More About The Technical Investor and The Technical Index & Bond Trading Strategies?

Learn how I use specific tools to help me understand price cycles, set-ups, and price target levels in various sectors to identify strategic entry and exit points for trades. Over the next 12 to 24+ months, I expect very large price swings in the US stock market and other asset classes across the globe. I believe the markets are starting to transition away from the continued central bank support rally phase and may start a revaluation phase as global traders attempt to identify the next big trends. Precious Metals will likely start to act as a proper hedge as caution and concern start to drive traders/investors into Metals.

I invite you to take a few minutes to visit the Technical Traders website to learn about our  Technical Index and Bond Trading strategy and how they can help you protect and grow your wealth.

Have a great day!

Chris Vermeulen
Chief Market Strategist

 

Stock Market: What to Expect in 2022?

Central banks’ game

As we kick off the new year, inflation risks are taking precedent over ongoing Covid headwinds and as a result, the U.S. Federal Reserve and other major global central banks are now beginning the process of withdrawing pandemic supports.

The Fed is now on track to end its asset purchases in March which would open the door for the central bank to start lifting its benchmark interest rate.

Wall Street anticipates between two to four rate hikes in 2022. The inevitability of higher borrowing costs in the year ahead poses some risk to stocks in highly-leveraged companies that are dependent on debt to fuel growth, as well as what some consider more “speculative” or “risky” assets.

Pandemic is still there

At the same time, companies that have already been successfully managing the rapidly shifting environment over the course of the pandemic and are sitting on healthy balance sheets are expected to see continued growth, though perhaps at a slower pace than 2021.

S&P 500 earnings growth for 2021 is estimated at a record of just over +45% with growth in 2022 currently pegged at around +9%. Most bulls think one of the biggest threats to growth stems from central bank themselves, which they worry could get overly aggressive in their efforts to reign in inflation and take the economy off the “life support” and heavy meds it has been on for the past many months.

Some Wall Street insiders fear central bank action will fail to curb inflation, leading to an environment of high interest rates on top of still-surging prices that ultimately strangles consumer spending and economic growth.

Investors are now weighing the risks the current Covid surge presents as it threatens to deepen existing global supply chain dislocations and labor shortages, in turn perhaps pushing inflation higher and putting even more pressure on the Fed to raise rates.

Wall Street mostly anticipates the new Omicron Covid variant will quickly burn itself out based on data from South Africa, where the strain was first detected. Omicron infections peaked in less than four weeks in South Africa so the hope is that it follows a similar path in the U.S.

Still, China’s zero-Covid policy has lead to more factory and port disruptions that, even if short in duration, could compound the supply chain worries.

Further inflation pressures could also be coming from the energy sector with more than -500,000 barrels per day of Libya’s output currently offline. The disruptions more than counter OPEC’s monthly production increase of +400,000 barrels per day, leading to renewed worries about a global oil crunch.

OPEC meets on Tuesday, January 4 and is expected to stick to its current production increase plan, though it’s not clear if other members will step in to make up for Libya’s production shortfalls.

Economic data to watch this week

Turning to economic data, inflation is in focus to start the week with the PMI Manufacturing Index due today, followed by the ISM Manufacturing Index on Tuesday, and the ISM Services Index on Thursday.

Inflation pressures for the manufacturing sector are expected to remain unchanged to slightly lower while service sector prices are seen rebounding higher.

Other key data includes the “minutes” from the Federal Reserve’s last policy meeting on Wednesday and the December Employment Report on Friday.

Earnings this week are very light with the biggest highlights being Bridgestone, Conagra, and Walgreens on Thursday. Keep in mind, Q4 2021 earnings season unofficially kicks off in less than two weeks with big bank earnings beginning on January 14.

The other big events to look out for will be next weeks CPI which will set the tone for the Fed and inflation. Another big event will be the Fed’s first FOMC meeting of 2022 and Powell’s first comments scheduled for January 26th. Remember, there’s no Fed meeting in February so there’s some talk that the Fed could be fairly aggressive with their comments and positioning in the January meeting.

I’m looking for a volatile January.

What History Says About 2022 Stock Market Performance During US Midterm Election Cycle

Last year in 2021, S&P 500 (SPX) gained 26.9% on the year, just less than 1% away from all-time high. It is the best performing index that beats Nasdaq Composite (IXIC), Dow Jones (DJI) and Russell 2000 (RUT).

Despite the outstanding performance last year, there are a few important events unfolding in 2022 where I have covered one of them – potential effect of macro environment on S&P 500. Next is the 4-years US election cycle.

Cycle Analysis for S&P 500 During US Midterm Election

US election has been an important catalyst for the stock market. Take a look at the annual seasonality chart for S&P 500 during the US midterm election cycle for the past 71 years below:

It is obvious that S&P 500 is in a trading range with increasing volatility to both sides. A pullback starts in January, April to September are the worst months for S&P 500 while the last 3 months are the best in terms of the performance. In short, S&P 500 is very choppy for the first 9 months and one might find the bull momentum is gaining traction only in early November.

The rationale behind the performance of S&P 500 during US midterm election cycle based on the seasonality chart is likely due to the implementation of the unpopular measures to curb the ever-increasing deficit of the government, tightening of the monetary policy with rate hike and tapering of the liquidity that are starting in January 2022.

Should 2022 behave similar to the history of the US midterm election, it will be a challenging year for the stock market when the volatility affects the stock price in both directions.

Trading Tactics for Volatile Trading Range

In a bifurcated market where S&P 500 is mainly in a trading range, the trading tactic is required to be adopted to suit the trading environment, such as to long the outperformers during the up-swing of S&P 500 and to short the laggards during the down-swing of S&P 500.

Visit TradePrecise.com to get additional market insights in email for free.

In case you are wondering if shorting is risky especially when the S&P 500 is near all-time high, refer to the post on how the market breadth behaves before a stock market crash, where you will discover many stocks outside of S&P 500 (especially the small cap stocks) hit new 52 weeks low since November 2021.

The key is to be nimble and to adjust the trading timeframe in order to beat the market in 2022 because a buy-and-hold or buy-on-dip strategy, which is typically a great strategy for up trending market environment, might not work well in a choppy and volatile trading range.

Unless you are a long-term investor who are willing to hold quality stocks such as buying Apple stock for years and not to be bothered by the volatility within a year or two, you are better reassess your current trading tactics in order to outperform the SPX in 2022 as the macro environment, midterm election cycle and the market breadth all point to a challenging market environment in 2022.

Did Central Banks Cancel The Christmas Rally?

Central banks are in the center of the game again

The BoE actually surprised traders with a rate hike at its policy meeting, a move most on Wall Street were not expecting until early next year. That follows the U.S. Fed’s decision to increase the pace of its asset purchase “taper” and projections for as many as three rate hikes in 2022.

In contrast, the European Central Bank last week effectively made no changes to its level of support, choosing to wait and see what, if any impacts the new Omicron Covid variant might have on the recovery. However, the EU is facing the same relentless rise in inflation as the U.S. and the UK, and many analysts anticipate ECB officials will be pressured to act sooner rather than later.

More than a dozen global central banks have already raised interest rates this year so the ECB is in shrinking company. Whether lifting interest rates will have a material impact on inflation is still very much up for debate. There is also a lot of uncertainty as how reduced central bank supports might ultimately impact stock prices.

Do the bears have a chance?

Bears warn that all this “easy money” has been the fuel behind much of the gains in stocks over the last year and a half. They believe less liquidity flowing into markets from the Fed’s asset purchase program threatens less risk appetite on the part of investors.

At the same time, higher interest rates are a threat to tech companies and other so-called “growth stocks” that may be dependent on high debt loads.

In other words, many larger investors are reallocating away from stocks that might struggle when the “easy money” actually dries up.

Bears are quick to remind us, in 2018, when the central bank raised the fed-funds rate while it also began trying to shrink its balance sheet, the S&P 500 nosedived nearly -20%.

On the flip side, bulls see strong US corporate earnings and big jumps in corporate revenue as reason for the big rally.

Revenue increase

Keep in mind, Amazon‘s revenues have increased massively from 2019s $280 billion to around $470 billion. google has seen its revenues jump from around $160 billion to 4210 billion.

Facebook has jumped its revenues form around $70 billion in 2019 to around $117 billion. I could go on and on but I think you get my point.

Some US businesses have seen massive jumps in revenue and earnings since Covid hit.

Those companies are much more heavily weighted in the stock indexes so they have been carrying the load.

That’s why we are seeing such a split-market right now. Investors are dumping stocks in companies that might not have the right playbook or leadership team to navigate in waters where money is tight and rates are much higher.

What about next week?

Looking to next week, the Christmas holiday season is officially upon us with markets closed on Friday, December 24, Christmas Eve. That’s the only change to market hours next week as Christmas falls on a Saturday. The short week does however bring several key economic releases, including the final estimate of Q3 GDP, Consumer confidence, and Existing Home Sales on Wednesday; and the PCE Prices Index, Personal Income & Outlays, Durable Goods Orders, New Home Sales, and Consumer Sentiment on Thursday.

 

Narrowing market breadth may be worrying signal for stocks

(Corrects name of firm in 5th and 14th paragraphs to AE Wealth Management from Advisors Excel Wealth Management)

By Saqib Iqbal Ahmed

NEW YORK (Reuters) – Investors are scrutinizing the stock market’s narrowing breadth and other signs of ebbing risk appetite, as markets digest a hawkish pivot from the Federal Reserve, soaring inflation and concern over a fresh wave of COVID-19 cases.

Only 31% of stocks in the tech-heavy Nasdaq are trading above their 200-day simple moving average despite the index’s 18% year-to-date gain, according to Refinitiv data, the lowest level in at least a year. That number stands at 36% for the small-cap-focused Russell 2000.

Stocks in the S&P 500 are faring better, with 68% of constituents trading above that moving-average mark. Still, just five stocks – Apple, Microsoft, NVIDIA, Tesla and Alphabet – have accounted for about half of the index’s gain since April, data published by Goldman Sachs earlier this week showed. The S&P is up about 24% for the year and stands near record highs.

Narrowing breadth can presage a period of rocky trading, with deeper-than-average drawdowns and weaker overall returns, Goldman’s data showed. The bank’s analysts said declines may be limited this time around by factors such as strong corporate earnings and a market that may have already priced in a more hawkish Fed.

Others are less sanguine. Tom Siomades, chief investment officer of AE Wealth Management, believes investors should brace for more market volatility.

“If you can’t live with that, you should definitely dial back a little bit of risk,” Siomades said.

The S&P is up 1.2% and the Nasdaq is off 2.4% this month, as the focus on an increasingly hawkish Fed has dried up risk appetite in some corners of the market. The central bank on Wednesday said it would accelerate the unwind of its asset purchases and it paved the way for three quarter-percentage-point rate increases in 2022, as it fights persistent inflation.

Frazzled nerves have also been apparent in the Cboe Volatility Index, known as Wall Street’s fear gauge, which stands about 5 points higher than its long-term median. High-growth stocks that thrived in 2020 have tumbled, along with many of the so-called meme stocks that have rallied this year.

The percentage of investors with a bullish short-term outlook for the U.S. stock market slid to the lowest level in three months in the latest American Association of Individual Investors Sentiment Survey (AAII), released Friday.

Investors next week will be watching U.S. consumer confidence numbers for a read on whether buyers are changing their purchasing habits in the face of worries of high inflation and COVID-19.

Narrowing breadth poses several potential risks for stocks, investors said.

“In order for the market to continue its advance, it becomes … reliant on fewer and fewer names,” said Peter Cecchini, director of research at Axonic Capital. “Any reversal in the performance of the names carrying the market won’t be met by strength in any of the other parts of the market.”

Concentrated positioning can also exacerbate volatility if risk appetite dries up suddenly, sending investors to the exits all at once.

“The door might not be wide enough to accommodate everybody that wants to rush out,” said Siomades, of AE Wealth Management.

There are signs that recently elevated volatility may be contained. Derivatives markets show volatility expectations falling between Christmas and New Years, said Garrett DeSimone, head quant at OptionMetrics.

That roughly coincides with a historically strong period for markets. Since 1945, the S&P has gained an average of 1.2% in the last five days of December and the first two days of January, according to data from CFRA, a phenomenon some investors have dubbed the Santa Claus rally.

Meanwhile, a survey of global fund managers by BoFA Global Research’s showed cash allocations at their highest level since May 2020. High levels of cash have in the past been a bullish sign for stocks, the bank said.

Narrow stock market breadth can continue for long periods and does not necessarily mean a sharp decline is coming.

Breadth in the S&P 500 narrowed for most of the second half of the 1990s, before the dot-com bubble burst around the turn of the century and during the latter part of the last decade, analysts at Capital Economics wrote.

Andrew Thrasher, a portfolio manager at Financial Enhancement Group, believes market breadth reveals the condition of the market but does not consider it a trading signal.

The past year “has been a poster child example of a market that can bend due to narrow breadth but not break as a result of it,” he said.

(This story corrects name of firm in 5th and 14th paragraphs to AE Wealth Management from Advisors Excel Wealth Management)

(Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Leslie Adler)