TSP Talk: Bulls take charge as bears get nervous
by
, 08-15-2022 at 01:11 AM (703 Views)
Stocks took Thursday's bearish negative reversal day - and on some charts a negative outside reversal day - even more bearish, and completely ignored that setup and rallied strongly to close at a multi-month high on Friday. The Dow gained an impressive 424-points, and the S&P 500 is now down less than 10%, which means it has cut its worst 2022 losses in half. The question is, will a 50% retracement of the losses pose any threat to the rally being a common Fibonacci retracement level? The CPI and jobs report data, and market moving earnings reports are basically behind us for a while, so the market will now have fewer catalysts through the end of the month.
The Fed has been raising interest rates and tightening their balance sheets in 2022 in an effort to curb inflation and reign in the economy. So, they can't be too excited about the rally in stocks, and yields falling sharply lately may not be what they wanted to see although the rising rates has the effect of slowing the economy which leads to lower yields.
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Oil moving down over the last two months has helped ease inflation and we saw that in the CPI report last week, and that may be what investors see as the pivot from the Fed as they monitor the economy, inflation, and to some degree, the stock market.
The yield on the 10-year Treasury is up since the early August lows but it may be just backing and filling after the open gap breakdown in July.
The 2/10 yield curve is still deeply inverted and that almost always means a recession is on deck. We can argue whether the 1st and 2nd quarter's negative GDP meant the country was in a recession, but being that the yield curve is inverted right now, it historically means a recession is still developing, and it is now as inverted as we have seen since before the dot com bubble burst in 2000.
As we mentioned back in April - I'm sure you remember - when the yield curve inverts it doesn't tend to mark an immediate market high. Instead, in the past the peaks came weeks, if not months later before the market really started to decline. The first inversion was at the end of March / beginning of April, and it inverted again in early July, where it has been buried below the flat line (0.00) since.
There were signs that the 1970's inflation was peaking in 1980, and in fact it did peak that year, but the stock market did not bottom until 1982. It's not an overnight process. And since then we have see bubbles, bear markets, and everything in between. We saw the market take on a new personality when the internet and modern web browsers became popular in the mid-90's, and why not? It changed the world - but it did eventually get out of hand, and the market corrected when the dot com bubble started to burst in 2000.
The S&P is back inside that long red trading channel and another test of the bottom of that channel during this financial hiccup is not a must, but it's possible as we saw tests in 2008, 2010, 2011, and again in 2020. But it all started when the market finally bottomed in 1982 after that 1970's inflationary period was finally dealt with.
So far this inflation crisis, if we can call it that, has only pulled the S&P down maybe 1/3 of the way into the channel, and the question is whether it will come down to test the bottom of that channel again before all is said and done? Or, can it break through to the top of the channel again despite valuations near other market peaks? That doesn't seem likely in the coming months.
The recent rally has the Forward Price / Earnings (P/E) ratio of the S&P 500 to near 19, and by the end of 2023 those estimates are below 17. Not that the stock market will stop on a dime because momentum is a force that is tough to stop, but the fundamental picture may not be as bright as the momentum traders are currently portraying. Do you think stock prices will go up while the P/E is falling?
All that said about the future being very uncertain, the action in the stock market has been bullish and the bulls have the momentum. Fighting momentum isn't the best strategy but if you're looking out months to a year, there are reasons to be cautious. It's whether or not you can be nimble and are willing to make some changes here and there. At some point this rally will run out of steam, whether it starts today, or weeks from now, it's tough to say when, but it is likely a when and not an if.
So, we've had a great bear market rally and it is now on the verge of either ending, or the bear market is about to turn into a bull market, and that's basically where most investors are sitting right now - one side or the other of that fence.
The S&P 500 (C-fund) had a big gain on Friday capping off a strong week for the stock market. Trading volume was very light, being a Friday in August, and that may become a pattern with the calendar getting quiet until September. There are still some open gaps below so the bulls may not want to get too comfortable, especially with the index stretched above the top of the trading channel. It is above the 200-day EMA and the June high so it perhaps resistance is of no consequence, but if the bulls get too complacent, the market could play humbler again.
The DWCPF (S-fund) has had a tremendous run, and as we mentioned, it seems to go further than anyone expects. The 200-day EMA is just overhead and getting above that would be the first time since the first few trading days of 2022. For those who have made a lot of money during this rally, the 200-day EMA could be a place where we could see some short-term profit taking.
This chart of the Dow Transportation Index, which is one of the more economically sensitive indices, successfully tested the June lows in July, and it has been straight up since, breaking through each level of resistance like a hot knife through butter.
But, if we look at that odd high from last November, and connect it with the March high, we see a little stiffer resistance in the area. That resistance line also happens to be parallel to the long-term resistance line, so there is some possible technical substance here.
The EFA (I-fund) had a big day but it lagged the U.S. indices because of the 0.39% rally in the dollar on Friday. It is above the trading channel but there are also open gaps below that could look to get filled on any profit taking.
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Thanks for reading. I appreciate it. We'll see you back here tomorrow.
Tom Crowley
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