Stock Market Commentary:
The stock market chopped into bearish conditions in the previous week. My reasons for bearishness were not obvious, but, as is typical, market breadth dynamics led my thinking. Last week, the stock market flagged very clear signs of bearishness. Resistance to the Fed in the form of disbelief in the process of normalization gave way to the bear. Fed-speak reminded the market one more time that the normalization of monetary policy is just getting started instead of coming to an imminent end. As a result, a lot of bets reliant on a Fed stuck in easy money mode continue to fall apart. At the same time, some segment of the market is racing ahead in fear of an economic disaster at the other end of normalization. Together, these forces are weighing ever more heavily on financial markets. The major indices tell the story.
The Stock Market Indices
For a brief moment, the S&P 500 (SPY) looked ready to take resistance to the Fed to a higher level. On Thursday the index peaked above converged resistance at its 20-day moving average (DMA) (the dotted line below) and 200DMA (the blue line). Instead, sellers took the baton and plunged the S&P 500 below 50DMA (the red line) support for a 1.5% loss. Friday’s deeper plunge confirmed both the failure at resistance and the breakdown. The S&P 500 re-entered bearish territory with a 2.8% loss. Since the index closed well below its lower Bollinger Band (BB), the coming week can easily open with a relief bounce. Such a moment will give bears a fresh opportunity to fade.
The NASDAQ (COMPQX) made bearishness even more clear. The tech-laden index’s resistance to the Fed failed to conquer 50DMA resistance. A 2.1% loss followed by a 2.5% loss confirmed 50DMA resistance and plunged the NASDAQ close to its March lows. Unlike the S&P 500, the NASDAQ is not yet over-extended. It closed right on top of its lower-BB.
The iShares Russell 2000 ETF (IWM) quickly transitioned from a 50DMA breakout to a confirmed 50DMA breakdown. Moreover, the ETF of small cap stocks is close to testing its January low. Twice I thought IWM was churning out a new trading range. Now IWM looks ready for an extended sell-off.
Stock Market Volatility
In my last Market Breadth post, I claimed that the volatility index (VIX) looked ready to maintain more elevated levels. Resistance to the Fed briefly returned the VIX to the important 20 level. The rush to believe the Fed took the VIX to a fresh 1-month high. On Friday, the VIX surged 24.4%. Given the influential history of VIX faders, I will not be surprised to see the VIX pullback before going still higher.
The Short-Term Trading Call With Resistance to the Fed
- AT50 (MMFI) = 33.9% of stocks are trading above their respective 50-day moving averages
- AT200 (MMTH) = 33.1% of stocks are trading above their respective 200-day moving averages
- Short-term Trading Call: cautiously bearish
AT50 (MMFI), the percentage of stocks trading above their respective 50DMAs, fell below 40% for the first time in 30 trading days. This breakdown serves as a second confirmation of the bearish implications of AT50’s failure just below the overbought threshold (70%) last month. If not for the short-term over-extended nature of the S&P 500 and the VIX, I would further downgrade my short-term trading call to bearish. Moreover, the low 30s is typically a time and place to start looking for reasons to get bullish. For example, just a few more days of selling could take the stock market right to oversold conditions (AT50 below 20%). As a compromise, I am standing pat on my cautiously bearish trading call.
The deep and aggressive selling in big cap tech stocks was particularly alarming. Until last week, most of this cohort held high the banner of resistance to the Fed. Accordingly, my bearish positioning turned out insufficiently aggressive. I took profits on a swath of my bearish positions on Thursday and early Friday only to find myself refreshing some positions later on Friday.
For example, my SPY calendar put spread hit its initial profit target early on Friday. I was hoping that the short side of the position would expire worthless and let me keep my long Apr 29 $435 put. As selling continued, I refreshed with a weekly SPY $425/$430 calendar put spread. I next moved to a Technology Select Sector SPDR Fund (XLK) May $142/$130 put spread. I also refreshed a bearish position on ARK Innovation ETF (ARKK) with an April 29/May $48 calendar put position. In each case, I allowed runway for relief rallies on the way to lower prices.
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 #508 over 20%, Day #33 over 30%, Day #1 under 40% (underperiod ending 30 days over 40%), Day #12 under 50%, Day #17 under 60%, Day #288 under 70%
Source for charts unless otherwise noted: TradingView.com
Full disclosure: long SPY call spread and put calendar spread, long IWM call spread, long XLK put spread, long ARKK put calendar
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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.