Stock Market Commentary:
After celebrating slightly weak economic data last Friday, stock market buyers and bulls have trained their eyes on the December CPI (Consumer Price Index) report. The bullish trading action for the last two days suggests market participants are expecting weaker than expected inflation data. In turn, such a report would strengthen hopes for a less hawkish Federal Reserve in the coming weeks. As bulls converge on the CPI report, market breadth approaches overbought trading territory. Thus, the CPI data represents a major make or break moment for the stock market’s current relief rally. I expected a notable disappointment from the CPI data, so my theory is being put to the test.
The Stock Market Indices
The S&P 500 (SPY) started the week rallying above its 50DMA only to fade to a flat close. That move favored the bears and looked like a top. I thought I would have to make my CPI trade in the middle of bearish which would make put options more expensive. However, buyers and bulls made an impressive comeback over the subsequent two days with a confirmed breakout above resistance at the 50-day moving average (DMA) (the red line). Suddenly, the index is just below a challenge of downtrending 200DMA resistance (the blue line).
I used the day’s rally to make a move on my CPI trade; I opened a SPY $390/$380 put spread expiring next Wednesday. Admittedly, I was not comfortable fading a confirmed 50DMA breakout, but I decided it was more important to put my CPI trade theory to a real test.
The NASDAQ (COMPQ) sliced through 50DMA resistance with a 1.8% gain. The move confirmed 20DMA support. If the tech-laden index confirms the breakout, a continued relief rally would create an upside target at the converged resistance of the 200DMA and the November highs.
The iShares Russell 2000 ETF (IWM) sliced through 200DMA resistance with a 1.3% gain. The move in turn confirmed a 50DMA breakout. A higher close would position IWM for a fresh run to resistance at the November/December highs.
Stock Market Volatility
The volatility index (VIX) refused to participate in the bullish tones of the stock market. The VIX gapped higher and somehow managed to avoid a fade back toward the 20 level. My eyes are still on resistance from the VIX’s 50DMA.
The Short-Term Trading Call When Bulls Converge
- AT50 (MMFI) = 64.6% of stocks are trading above their respective 50-day moving averages
- AT200 (MMTH) = 49.5% 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, surged with the stock market last week and did so again this week. AT50 even held a small gain while the S&P 500 faded into negative territory on Monday. The 64.6% close on a 6 percentage point gain positions my favorite technical indicator for a quick test of the overbought threshold at 70%. A favorable December CPI report should provide the catalyst for just such a follow-through surge. I will have to downshift my short-term trading call to neutral if AT50 closes overbought. That stubborn move would provide a launching pad for the major indices to push into and even past the next layers of major resistance.
The Australian dollar vs the Japanese yen (AUD/JPY) is currently looking to play spoiler. This forex indicator of market sentiment fell short of overhead 50DMA resistance for the second day of three. At the time of writing, AUD/JPY is fading from resistance and signaling disappointment in the stock market for Thursday. Of course, a surprisingly low December CPI could overwhelm this technical warning. A December CPI that meets my expectations for disappointment would validate this early signal.
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 #61 over 20%, Day #57 over 30%, Day #6 over 40%, Day #4 over 50%, Day #1 over 60% (overperiod), Day #27 under 70% (underperiod)
Source for charts unless otherwise noted: TradingView.com
Full disclosure: long IWM put, long QQQ put spreads, long SPY put 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.
My first try at this CPI surprise trade could end up directionally correct, but not for the reasons explained in this theory. The nowcast for December core CPI was 5.87%. Actual came in at 5.7%. So, the nowcast was too high yet again. The “consensus” core CPI forecast nailed the number. Based on the market’s reaction at the time of writing, the market is likely trading based off that consensus number.
At the time of writing, the S&P 500 gapped up slightly (as I would expect given the nowcast was too hot again) but faded hard right at 200DMA resistance. The NASDAQ faded back under its 50DMA. I *suspect* these pullbacks can be easily explained as technical, especially with the market rallying so strongly into the December CPI report “expecting weaker than expected inflation data.”