Stock Market Commentary
Investor psychology took another hit. A spirited relief rally turned into a dispiriting fade and reversal that had tinges of bear market action. The bear-like fade stretched the stock market closer to oversold trading conditions. All three major indices covered here are now setting multi-month lows. They are also very extended to the downside relative to their lower Bollinger Bands (BBs). Market breadth closed at important depths which sets up a key test of buyer interest in the growing number of “bargains” littered across the ticker tape.
The Stock Market Indices
The S&P 500 (SPY) enjoyed a strong start to the day. The 1.5% gain at the highs looked like the typical relief bounce off the over-extended conditions that I described in my previous post. Suddenly, the index began a bear-like fade. The slippage coincided with a CNBC report about a demand-driven production halt at Peloton Interactive, Inc. (PTON). If this news really catalyzed the cascade of selling, then traders looking to take advantage of the relief rally just got an excuse to sell.
The S&P 500 closed below its lower-BB for the second day in a row. This kind of selling pressure happened just ONCE after the rally started off the pandemic lows (see the September lows below). Such is the power of an easy-money Federal Reserve. Even with the prospects of a fresh relief bounce, a test of support at the 200-day moving average (DMA) (the blue line below) is in play as eventual follow-through to the bear-like fade.
The NASDAQ (COMPQX) already failed its last test of 200DMA support. The 1.3% loss and 7-month low on the tech-laden index is the third straight close below this critical line of support. Suddenly, the NASDAQ is down 9.5% for the year in less than 3 weeks. It is now clinging to a 9.8% gain measured from the end of 2020.
The iShares Russell 2000 ETF (IWM) continued its breakdown with a 1.8% loss and 52-week low. The ETF of small caps has almost wiped out all its hard-earned gains from 2021. If IWM scoots below the year-opening gap of 2021, there is a slippery slope offering few natural supports to slow down subsequent selling.
Stock Market Volatility
The volatility index (VIX) surge is now on day number three. The day’s 7.3% gain pushed the VIX above its own upper-BB. This milestone makes the “surge clock” tick even louder. The VIX faders are surely salivating right about now.
The Short-Term Trading Call with A Bear-Like Fade
- AT50 (MMFI) = 27.4% of stocks are trading above their respective 50-day moving averages
- AT200 (MMTH) = 34.6% of stocks are trading above their respective 200-day moving averages
- Short-term Trading Call: neutral
AT50, AT200 and the three major indices are quite stretched to the downside. With the VIX surging into an extended position to the upside, combined conditions are ripe for another relief rally. Accordingly, AT50 may not drop into true oversold territory (below 20%) for this cycle of selling. Today’s bear-like fade is the main trading feature tempering my short-term expectations. Moreover, the S&P 500 looks “due” for a test of 200DMA support. The index last tested this critical support line the last time AT200 traded at current levels…19 months ago.
Typically at this kind of extended juncture, I would flip the trading call to cautiously bullish in preparation for likely oversold conditions. However, the current trading action is too ugly (a technical term). Today’s bear-like fade had the feel of a bear market in the making. S&P 500 tests of 200DMA support and/or 50DMA resistance will serve as more information to clarify the bear vs bull flavor of the market. Note that a market that quickly bounces out of oversold conditions is not likely bearish. Breakouts after the current extended conditions act like confirmations of a bullish change in tenor.
Surprisingly, the Australian dollar versus the Japanese yen (AUD/JPY) remains well off the lows from December. Either the stock market has a lot more downside ahead, or the currency markets are telling me that “risk-on” trading will resume shortly.
Be careful out there!
Footnotes
“Above the 50” (AT50) uses the percentage of stocks trading above their respective 50-day moving averages (DMAs) to measure breadth in the stock market. Breadth defines the distribution of participation in a rally or sell-off. As a result, AT50 identifies extremes in market sentiment that are likely to reverse. Above the 50 is my alternative name for “MMFI” which is a symbol TradingView.com and other chart vendors use for this breadth indicator. Learn more about AT50 on my Market Breadth Resource Page. AT200, or MMTH, measures the percentage of stocks trading above their respective 200DMAs.
Active AT50 (MMFI) periods: Day #444 over 20%, Day #1 under 30% (underperiod ending 19 days over 30%, Day #3 under 40%, Day #11 under 50%, Day #44 under 60%, Day #224 under 70%
Source for charts unless otherwise noted: TradingView.com
Full disclosure: long QQQ call spread, long IWM calls
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*Charting notes: Stock prices are not adjusted for dividends. Candlestick charts use hollow bodies: open candles indicate a close higher than the open, filled candles indicate an open higher than the close.
I brought up this exact scenario in comment 2 weeks ago…..MMFI around 20 with SPY at the 200 day MA…..buying call spreads for this next week or sitting it out….QQQ and IWM make me think if we have a bounce it will be the short lived head fake kind..
I remember. And the big test is here. I bought a Feb 04 $450/$460 call spread as the S&P 500 tested 200DMA support and AT50 inched closer to the oversold threshold. That will be my last such trade ahead of official oversold conditions.