Safety Trades Surge As Stock Market Stumbles Toward Oversold – The Market Breadth

Stock Market Commentary:

The runway for (short-term) bearishness has greatly shortened. The classic safety trades sprung to life to add exclamation points to the broadening sell-off. After over 6 weeks of near relentless losses, the Japanese yen (FXY) caught a strong bid. Inflation fears returned to the background as traders eased into Treasury bonds (per my pre-Fed strategy, I faded the move with May TLT puts). These turn of events coincide with the approach of oversold trading conditions. While last week’s snapshots of fresh bearishness confirmed market sentiment was finally tuning into the Fed’s hawkish determination. The awakening is reaching an overshoot that could easily exhaust motivated selling anytime this week.

The Stock Market Indices

I find it hard to believe that four trading days ago, the S&P 500 looked set for a significantly contrary breakout above its 200-day moving average (DMA) (the blue line below). In a flash, the index has closed just short of its March and 2022 closing lows. The rush downward included a brief rally off intraday lows. That false move was strong enough to take the S&P 500 back into the green. If the March lows give way, the S&P 500 needs to hold May, 2021 support to avoid significantly more downside risk.

The NASDAQ (COMPQX) led the market’s bearishness with a confirmed failure at 50DMA (the red line below) resistance. Now the tech-laden index has returned to bear market territory with a 16-month low. With all of 2021’s gains gone, the NASDAQ has more downside risk to the November, 2020 lows. Unfortunately, strong rallies to the upside leave precious few “natural” levels of support on the way down.

The iShares Russell 2000 ETF (IWM) finally broke down with a 3.2% loss and a near 17-month low. The ETF of small caps quickly flipped from a potentially bullish 50DMA breakout last week to a very bearish breakdown.

Stock Market Volatility

The volatility faders are probably getting itchy. The volatility index (VIX) surged 24.1% and closed well above its upper Bollinger Band (BB) for the second day out of three. The middle day featured a fade that only pushed the VIX back to the BB border. Accordingly, volatility is extremely stretched and subject to a sharp pullback at anytime. In the meantime, the VIX looks ready to challenge recent highs.

The Short-Term Trading Call With Resistance to the Fed

• AT50 (MMFI) = 24.9% of stocks are trading above their respective 50-day moving averages
• AT200 (MMTH) = 29.2% of stocks are trading above their respective 200-day moving averages
• Short-term Trading Call: neutral

AT50 (MMFI), the percentage of stocks trading above their respective 50DMAs, closed at 24.9%. This important indicator of market breath trades just five percentage points away from oversold conditions. My favorite technical indicator fell as low as 25.8% the previous day before a relief rally unfolded. On the surface, the rebound looked like a rebound from “close enough” oversold conditions. However, I had to ignore the buying given the bad news that started the day: Russia stubbornly declaring it saw no need for a ceasefire in its invasion of Ukraine (as reported by briefing.com through Reuters). Moreover, I could not identify any encouraging spark of news to validate the rally. Thus, with my short-term trading call cautiously bearish, I took profits on just two bearish positions and held the rest.

Still, trading conditions are getting extreme. AT50 is close to oversold, the VIX is well above its upper-BB, the NASDAQ is already down 12.1% for the month, and the safety trades in the Japanese yen and Treasury bonds are suddenly popular. This combination means a greatly diminished risk/reward for remaining stubbornly bearish. Accordingly, I changed my short-term trading call to neutral. I took some more profits on bearish positions and plan to close out most of the rest in the next trading session.

Given the growing extremes, I nibbled on some bullish positions. They are like partial hedges in case I get caught by a major gap up in the market Wednesday. (The current action in AUD/JPY suggests the odds are high for at least a small gap up to start trading in the stock market – see “Why the Australian Dollar and Japanese Yen Matter for Stock Traders” for more info). I bought a small number of shares in ProShares Short VIX Short-Term Futures ETF (SVXY) and SPY. Both are short-term positions. If the market rallies without first dropping into oversold conditions, I will stay neutral. I see a lot of overhead resistance for this market until we get beyond the Federal Reserve’s May meeting on monetary policy.

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 #510 over 20%, Day #1 under 30% (underperiod ending 24 days above 30%), Day #3 under 40%, Day #14 under 50%, Day #19 under 60%, Day #290 under 70%

Source for charts unless otherwise noted: TradingView.com

Full disclosure: long SPY call spread and put calendar spread and shares, long IWM call spread, long TLT puts

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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.