Stock Market Commentary:
Forget recession fears. Forget an aggressively hawkish Fed. Forget the stock chart holdouts. Bullish belief delivered another powerful confirmation of what has become an exceptionally strong bounce from March’s nervous test of the last oversold point. The rally launched from the March lows and barely rested or paused. The rally has been the very definition of indefatigable trading. Each index took its own path, but the rally narrative has been surprisingly consistent thanks to the leadership of the S&P 500. However, overbought conditions now loom for the stock market just as headlines about Russia’s invasion of Ukraine take on increasingly encouraging tilts. Market breadth and the currency market point to a potential climax around the corner. A potential climax is not necessarily a time to get bearish, but it is a time to get more wary. The rules of trading market breadth return to my spotlight.
The Stock Market Indices
The S&P 500 (SPY) is suddenly only down 2.8% for the year. The index has enjoyed 9 out of the 11 trading days planted firmly in positive territory. During this time, the S&P 500 sliced through resistance at its 50-day moving average (DMA) (the red line below) and used its 200DMA (the blue line below) as a fresh launching pad. Contrary to my expectations, the index did not even pause for a rest at the double peaks in February. I took profits on my $450/$455 SPY call spread expiring next week and held my April $360/$370 call spread. I see a potential climax featuring an S&P 500 making a run at its all-time high.
The NASDAQ (COMPQX) also slipped right by its February double peak. The tech-laden index has chopped a little more than the S&P 500, but its run-up is just as impressive. Recall that the NASDAQ was suffering in bearish territory before this rally began in earnest. Now, the NASDAQ is toying with overhead resistance at its 200DMA. I chose not to wait for the resolution of this critical moment and took profits on a $360/$370 April call spread. I swapped in April $71 call options on the Communication Services Select Sector SPDR Fund (XLC). XLC is a more conservative play on big-cap tech names. Accordingly, I figure it can weather a potential climax better than QQQ. XLC gained 1.7% on a 50DMA breakout.
Notably, QQQ cleared 200DMA resistance. However, I continue to take cues on tech from the NASDAQ. A 200DMA breakout would usher in a fresh wave of bullishness for tech stocks. Such a phase could make the potential climax particularly explosive to the upside before buyer’s exhaustion finally appears. My trades left behind a rapidly fading hedge in an April $350/$340 QQQ put spread.
At the end of last week, I concluded that the iShares Russell 2000 ETF (IWM) was growing a new trading range. I prepared to take minimal profits on my April $202/$207 call spread. A swift gap up and 2.7% gain made my position look far too conservative. I took profits on the call spread given I have little else to gain and a lot to lose between here and expiration. Maybe a potential climax can take IWM to a critical test of 200DMA resistance before buyer’s exhaustion sets in.
Stock Market Volatility
The volatility index (VIX) knows no bottom yet. Not even the important 20-level slowed the VIX down. February’s lows are in the rear view mirror, and the 2022 lows are in view.
The Short-Term Trading Call with A Potential Climax
- AT50 (MMFI) = 66.0% of stocks are trading above their respective 50-day moving averages
- AT200 (MMTH) = 44.0% of stocks are trading above their respective 200-day moving averages
- Short-term Trading Call: cautiously bullish
AT50 (MMFI), the percentage of stocks trading above their respective 50DMAs, only marginally served to uphold bullish belief at the close of last week. Today’s 10 percentage point surge delivered a convincing confirmation of bullishness. The breakout and surge left behind 7 days digesting the last breakout which in turn cleared the former high of the year.
The path of a potential climax now looms as a “final” question. As a reminder, the overbought threshold sits at 70% for AT50. The AT50 trading rules remind me that a reversal from or breakdown below the overbought threshold is a (short-term) bearish event. Overbought trading conditions are not bearish. However, I will likely turn neutral during oversold conditions in anticipation of a potential climax.
I turn to the currency market for clues on the potential climax. The Australian dollar versus the Japanese yen (AUD/JPY) has finally paused during an incredible parabolic run-up this month. AUD/JPY looks like it is at a tipping point. A close below 91, and especially 90, would provide a strong topping signal. Otherwise, a potential climax could be quite explosive to the upside.
The Bank of Japan (BoJ) is defending its easy-money policies with a promise to buy unlimited Japanese Government Bonds (JGBs). The BoJ does not see an inflation problem in Japan, especially relative to the U.S. and Europe. The central bank offered three hypothesis for the relatively low inflation in “The COVID-19 Crisis and Inflation Dynamics: Opening Remarks at the Workshop on ‘Issues Surrounding Price Developments during the COVID-19 Pandemic‘ by AMAMIYA Masayoshi, Deputy Governor of the Bank of Japan:
- Japanese households’ strong risk aversion has limited pent-up demand for private consumption.
- The waning of the pandemic has revived the Japanese corporate “norm” of deflationary thinking – the “assumption that prices will not increase easily.”
- Service prices remain relatively weaker (although Masayoshi called on a review of statistical practices).
The BoJ’s response makes holding yen even more painful. Easy money policies are compounding the trade balance pressures with countries that export the commodities Japan needs. Selling yen to buy higher-yielding assets provides yet more fuel for risk-on behavior. I am more tuned in than ever now.
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 #491 over 20%, Day #16 over 30%, Day #10 over 40%, Day #8 over 50%, Day #1 over 60% (overperiod ending 90 days under 60%), Day #271 under 70%
Source for charts unless otherwise noted: TradingView.com
Full disclosure: long QQQ put spread, long SPY call spread, long XLC calls, long AUD/JPY
FOLLOW Dr. Duru’s commentary on financial markets via StockTwits, Twitter, and even Instagram!
*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.