A Surge And A Major Fade Ring in the New Year – The Market Breadth

Stock Market Commentary

The strong end to 2021 mattered for just one day so far in 2022. Presumably fresh passive investments helped create a broad surge on the first day of the year. Wednesday’s release of the minutes from the Federal Reserve’s December meeting changed everything. Apparently, the Fed talk sounded a lot more hawkish than expected. Subsequently, a broad-based sell-off took stocks down. The major fade reversed the market’s new year cheer. The indices suffered big losses and market breadth suffered a major setback. Stocks limped their way from there. An underwhelming December jobs report failed to produce a bad news is good news (less hawkish Fed) reaction.

“…participants judged that the appropriate timing of balance sheet runoff would likely be closer to that of policy rate liftoff than in the Committee’s previous experience. They noted that current conditions included a stronger economic outlook, higher inflation, and a larger balance sheet and thus could warrant a potentially faster pace of policy rate normalization. They emphasized that the decision to initiate runoff would be data dependent…

Many participants judged that the appropriate pace of balance sheet runoff would likely be faster than it was during the previous normalization episode.”

Minutes of the Federal Open Market Committee, December 14-15, 2021

The Stock Market Indices

The S&P 500 (SPY) started the new year with a 0.6% gain and a marginal all-time high. A small gain the next day melted into a small fade. The hawkish Fed news took the index down 1.9%. The last two days of the week featured battles with support at the 50-day moving average (DMA) (the red line below). I bought a weekly January $472/$477 SPY call spread to play the index’s pattern of bouncing off this reliable support level. If support fails, I will not buy the SPY again until 1) oversold conditions and/or 2) a confirmed 50DMA breakout.

The NASDAQ (COMPQX) is once again lagging the S&P 500. Not only did the tech-laden index suffer a whopping 4.5% loss, but also it closed right around the December intraday lows. Ahead of the Fed meeting minutes I bought a QQQ calendar call spread that blew up relatively quickly. The NASDAQ looks poised to test 200DMA support (the blue line) for the FIRST time since April, 2020, almost two years ago.

The iShares Russell 2000 ETF (IWM) suffered along with the rest of the market. The index of small caps lost 2.9% for the week. The only trade on IWM for the week would have been to try a fade from resistance. IWM remains a play on the trading range until further notice.

Stock Market Volatility

Given the overall disappointing start to the new year, I would have expected the volatility index (VIX) to surge right through 20 and challenge the December highs. Instead, the faders managed to take the VIX off the week’s high and close it below 20. This divergence from the lagging indices make me think some kind of rebound awaits the coming week…or at least follow-up selling will not be as bad as last week.

The Short-Term Trading Call After Santa Ended 2021 Strong

• AT50 (MMFI) = 41.9% of stocks are trading above their respective 50-day moving averages
• AT200 (MMTH) 44.6% of stocks are trading above their respective 200-day moving averages
• Short-term Trading Call: bullish

AT50 (MMFI), the percentage of stocks trading above their respective 50DMAs, ended the first week of the new year at 41.9%. AT50 ended 2020 at that exact same point. Given the selling to start the year, I would have expected worse performance from market breadth. So like the signal from the VIX, I assume market breadth is flagging an easier time for the market in the coming week. Accordingly, I kept the short-term trading call at bullish.

I am not a comfortable bullish. After all, AT50 looks like it printed another false breakout. Thus the trading pattern could be the start of an eventual trip toward or to oversold conditions. So if the S&P 500 confirms a 50DMA breakdown, I will quickly downgrade to cautiously bullish.

Moreover, after spending much of the week taking profits on hedges (and lamenting losses in key long positions), I moved right into fresh hedges on Friday. In particular, I noted that put options in Cathie Wood’s flagship ARK Innovation ETF (ARKK) are a particularly good hedge in an environment where premium valuations are compressing. Expectations for tighter monetary policy are steadily eroding risk-seeking and increasing risk aversion. I flipped through an ARKK put spread on Thursday and bought a February $74.22 put option on Friday. ARKK is likely an even better measure of risk tolerance than the AUD/JPY currency pair.

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 #436 over 20%, Day #12 over 30%, Day #10 over 40% (overperiod), Day #3 under 50% (underperiod), Day #36 under 60%, Day #216 under 70%

Source for charts unless otherwise noted: TradingView.com

Full disclosure: no positions

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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.