Stock Market Commentary:
The stock market is expressing its disappointment with the Federal Reserve’s plans to tighten monetary policy. The Fed will have the backdrop of a sharp market sell-off when it meets this week to further execute on those plans. Like a forlorn partner, stocks sent a wistful love note to the Fed asking for more sympathy. Assuming the Fed turns a cold shoulder this round, I will brace for a repeat performance ahead of the March 15-16 meeting. The question will soon become what will it take to force the Fed to capitulate on its hawkish plans…with little appreciation for the $9 trillion size of the balance sheet or interest rates barely above zero.
The Stock Market Indices
The S&P 500 (SPY) lost 1.9% and finally broke down below its 200-day moving average (DMA) (the blue line below). The longer-term chart shows that the index last traded below its 200DMA back in June, 2020. Even more importantly for now: the index finally made a major new low. The technical pattern shows a topped out index (see the 4700 parallel) with the October low in play. If that support fails, the S&P 500 could well be on its way to enter an official bear market.
However, before I get ahead of the prevailing winds, the stock market is almost in oversold conditions. As a result, there is likely only so much further the S&P 500 will fall before a significant oversold bounce unfolds. Accordingly, I bought an S&P 500 $450/$460 call spread expiring February 4. I chose the design to survive whatever churn the Fed meeting brings and provide enough time for an oversold bounce to stretch toward overhead 50DMA resistance (the red line).
The NASDAQ (COMPQX) is down 14.3% from its all-time high. The tech-laden index zipped through correction territory and is approaching bear market territory. A 20% pullback would put the NASDAQ at 12,846. At that price level, the NASDAQ would reverse all its 2021 gains. The NASDAQ closed 2020 at 12,888. Such a rollback seems like a plausible target in a stock market where more and more growth and otherwise expensive stocks are blowing up their pandemic era gains. This kind of reversal symbolizes the power Fed has in just talking about what it wants to do. Nothing significant has happened yet.
The iShares Russell 2000 ETF (IWM) ended 2020 at 196.06. IWM closed the week at 196.99. Count those 2021 gains as so much vapor. IWM is almost in bear market territory with an 18.8% loss from the all-time high set just in November.
Stock Market Volatility
The volatility index (VIX) held the faders at bay with a fourth straight day of notable gains. The VIX gained 12.7% and stopped just short of the December closing high. The volatility faders must be salivating a LOT now.
The Short-Term Trading Call with A Forlorn Stock Market
- AT50 (MMFI) = 22.2% of stocks are trading above their respective 50-day moving averages
- AT200 (MMTH) = 31.3% of stocks are trading above their respective 200-day moving averages
- Short-term Trading Call: neutral
AT50, AT200 and the three major indices are extremely stretched to the downside now. A sharp relief rally can erupt at any time. However, if traders and investors are really concerned about what the Fed might do or say, any forlorn buying just ahead of the news will likely be tepid. It should take the “buy on the news” crowd to really get a good relief bounce going. (Look out below if the Fed manages to surprise the market with stauncher hawkishness!)
In times like these, I appreciate my trading rules even more. The rules allow me to keep the trading simple and to put the news and context in proper perspective. I have already done enough “pre-oversold” nibbling. I now await true oversold conditions, AT50 below 20%, to get aggressive. The higher the VIX goes with the market oversold, the more aggressive I get. Given the proximity of the oversold threshold, I will flip the short-term trading call to bullish on an intraday drop below the 20% threshold.
The Confirmation from the Currency Market
Finally, I am still tracking the messages from the currency market more closely. The Australian dollar versus the Japanese yen (AUD/JPY) made a more decisive move on Friday. The 50DMA breakdown confirmed on-going risk aversion in financial markets. Now AUD/JPY implies more selling is coming to start the week. Bring on oversold territory.
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 #445 over 20%, Day #2 under 30% (underperiod), Day #4 under 40%, Day #12 under 50%, Day #45 under 60%, Day #225 under 70%
Source for charts unless otherwise noted: TradingView.com
Full disclosure: long QQQ call spread, long IWM calls, long SPY call spread
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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.