Mid-week market update: For several weeks, sentiment surveys such as AAII and Investors Intelligence have signaled extreme levels of bearishness seen at past market bottoms. However, some observers have played down the sentiment surveys because indications of positioning are inconsistent with extreme fear. As an example, funds are still pouring into the Cathie Wood’s Ark Investment ETFs even as the speculative growth vehicles tank. That’s not the sort of behavior seen at washout bottoms. On the other hand, I have received a flood of emails and other messages of concern about the stock market indicating growing fear and panic.
To resolve the dilemma, my publication
“How to spot a market bottom” published on March 19, 2022 offered a useful checklist that I’ll go through.
Market bottom checklist
The checklist consisted of:
- Insider activity;
- Market positioning in futures; and
- Oversold and breadth indicators.
Let’s go through them, one at a time. Recent insider activity showed a brief flash of more buying (blue line) than selling (red line), which is constructive. We saw a similar episode during the short-term bottom in January.
As a reminder, insiders were buying hand over fist during the GFC market bottom.
We also saw clusters of much stronger insider buying during the Greek Crisis of 2011.
Insiders similarly stepped up their buying during the COVID Crash.
The takeaway from insider activity is these “smart investors” do not signal tactical trading bottoms, but intermediate and long-term market bottoms. While current activity is mildly constructive, we aren’t quite there yet.
As for futures positioning, the latest Commitment of Traders report, which was published last Friday based on the data from the previous Tuesday (May 3, 2022) shows that large speculators held a minor long position in S&P 500 e-minis, but the momentum was negative. However, futures positioning have tended to lag major market bottoms owing to the lagging nature of trend following CTA programs.
The COT picture for the NASDAQ 100 futures shows a similar minor long position and historically lagging positioning signals.
From a technical perspective, the good news is one of the main technical indicators shows that the market has reached the minimum threshold for an intermediate bottom.
I have highlighted the “good overbought” advance from the March 2020 bottom before. This was evidenced by the percentage of S&P 500 stocks above their 200 dma rising to 90% and remaining there. The overbought condition recycled in mid-2021 (top panel). Historically, such declines don’t end until the percentage of stocks above their 50 dma fall below 20% (bottom panel).
The percentage of S&P 500 stocks below their 50 dma fell below 20%, which is the minimum criteria for a bottom. At this point, investors have to make a decision as to whether the current market downdraft represents a minor pullback or a major bear market. If it’s a minor downdraft, the bottom is in. In a major bear market, this indicator has fallen to as low as 5%, though the current sub-20% reading could be a setup for a relief rally, followed by further losses.
The NYSE McClellan Summation Index (NYSI) has signaled major market bottoms when it fell to -1000 or less. The NYSI is far from that reading, but the market has bottomed at current levels in 2011 and 2015-16.
Other breadth indicators which weren’t part of the checklist are sufficiently oversold to signal a possible bottom.
A rally within a downtrend
I interpret these conditions as the market is setting up for an imminent relief rally within the context of an intermediate downtrend. I recently pointed out that S&P 500 valuations are not attractive enough for a major market bottom (see Profit opportunities in the coming global recession
On the other hand, I was surprised that the stock market didn’t immediately tank on the hot April CPI report this morning. While core PCE and core CPI are decelerating, the pace of deceleration is uneven. The long-awaited decline in durable goods CPI is finally evident (see used cars), but services CPI is stubbornly strong, paced by an acceleration to a 0.5% MoM increase in heavyweight Owners Equivalent Rent from 0.4% the previous month, and an astounding 18.6% MoM rise in airfares. These conditions allows the Fed to stay on its hawkish tightening path, but stock prices didn’t immediately respond. By contrast, the 2-year Treasury yield rose, which is a proxy for the market’s estimate of the Fed Funds terminal rate, while longer dated Treasury yields fell, indicating the expectations of a slowing economy.
In the meantime, the NYSE McClellan Oscillator (NYMO) is oversold, where the vertical lines on the chart are buy signals when NYMO recycles from oversold to neutral.
The Zweig Breadth Thrust Indicator is also in oversold territory. Major bear legs simply don’t start in such extreme conditions.
My inner investor is cautiously positioned. My inner trader has a few nicks on his hands from trying to catch falling knives, but he is positioned for a counter trend rally.
Disclosure: Long SPXL