Waiting for the breakout (or breakdown)

Posted by Cam Hui -

Mid-week market update: As the S&P 500 consolidates its gains in a narrow range after its surge last week, it has been a frustrating time for both bulls and bears. 
 

 

As investors wait for either the breakout or breakdown from the range, here are the bull and bear cases.

 

 

A mixed sentiment picture

First, sentiment presents a mixed picture. A variety of (unscientific) Twitter polls lead to wildly different conclusions.

 

Helene Meisler’s weekend poll saw the consensus change from wildly bullish to slightly bearish. The last time a slightly bearish reading followed a string of bullish readings occurred in December when the market topped out. That’s bearish, right?

 

 

Not so fast. Callum Thomas also conducts a weekend Twitter poll. Respondents were bearish, which is contrarian bullish.

 

 

Charlie Bilello recently asked if the recent rally is a dead cat bounce or the real thing, and the consensus is “dead cat bounce”, indicating excessive bearishness.

 

 

My head hurts from thinking about sentiment. Poll results are wildly different and it’s difficult to make any definitive conclusions.

 

 

A butterfly flaps its wings in Beijing

The most bullish development may not be immediately evident to American investors. China’s technology sector has been experiencing a broad-based rally on strong volume, indicating institutional participation. Authorities approved about 60 new video games and eased a crackdown on the sector which began last year. A report earlier this week that regulators were looking to end a probe into Didi Global Inc. also helped sentiment.

 

At the same time, SentimenTrader also reported strong insider buying among NASDAQ 100 stocks.

 

 

From a technical perspective, the relative performance of the NASDAQ 100 to the S&P 500 and Chinese internet stocks to MSCI China have turned up. These developments are supportive of a bullish impulse led by the technology sector.

 

 

Longer term, both the NASDAQ 100 and EM internet and e-commerce stocks are very oversold and due for a turnaround.

 

 

Even ARK Innovation (ARKK) is performing well, both on an absolute and relative basis.

 

 

The NYSE McClellan Oscillator (NYMO) recently became wildly overbought and recycled from its overbought reading. Past experiences has shown that while the market has paused its advance in the past, downside risk has been relatively low and stock prices have continued to advance in most instances of a similar nature.

 

 

 

The challenges ahead

Looking ahead, the bulls face some challenges, starting with tomorrow’s ECB decision, Friday’s CPI report and next week’s FOMC meeting could be sources of volatility.

 

The ECB is expected to turn hawkish in the face of strong inflationary pressures. It will signal an end to asset purchase and a commitment to raise rates in the near future.

 

 

On Friday investors will get the all-important CPI report, which will be watched closely by the Fed ahead of the FOMC meeting next week. While core CPI is expected to decelerate, volatile components such as used car prices aren’t cooperating. The latest Manheim report saw prices edge up. Owners’ Equivalent Rent, which is a significant component of CPI, is expected to firm as well.

 

 

Looking ahead to the FOMC announcement, half-point hikes are already baked into expectations for the next two meetings. The key question for investors is how expectations move for the September meeting. While the market is pricing in another half-point increase in September, the probability estimate is far less certain.

 

 

Vice-Chair Lael Brainard stated in a CNBC interview, “It’s very hard to see the case for a pause.  We’ve still got a lot of work to do to get inflation down to our 2% target.” In light of the strength in the April JOLTS and May Jobs Report, the Fed appears to be prepared for an even more hawkish pivot.

 

So where does that leave us?

 

My inner investor remains defensively positioned. My inner trader is bullish but he has trimmed his long positions. While he is hopeful that the S&P 500 can stage an upside breakout, his risk control discipline calls for him to exit his longs should the market break down from the recent trading range.

 

 

Disclosure: Long SPXL

 

19 thoughts on “Waiting for the breakout (or breakdown)”

  1. Intel gave lower guidance. The stock is down and close to its previous low. It will interesting to see how the stocks acts here together with the semi-conductor index. Not falling apart will be a bullish sign and it will indicate the likelihood of a breakout of the NDX.

  2. My thoughts this evening can be summarized as ‘tired of playing the volatility and willing to place a measured bet on a sustained upside reversal.’

    I began scaling in this morning (early as usual – but that’s why I scale in). Added a second allocation near the intraday lows. Plan to add further on Thursday regardless of price action. If the market gaps down – I plan to add a third allocation. If the market gaps up and gaps up over SPY 417 – I plan to add a third allocation. If the market opens flat, I’ll wait for SPY 407 or 417 to add further. Ultimate position size will be ~60-70% of the portfolio. I also began scaling into bonds – but I’m more bullish on equities over the next several weeks.

  3. Market just playing ping-pong and building a triangle between 4100-4170 – timing the market is incredibly difficult, but if I had to do it, I would expect us to zig-zag higher for just a few more weeks and then stage a pretty dramatic reversal to the downside. Not sure when exactly the reversal would be starting, but going long into Q2 earnings season seems pretty risky given the possible negative surprises. Markets tend not to crash during the summer doldrums, but I wouldn’t press my luck holding longs into August. September/October volatility could be pretty ugly this year if the markets want to go down that route.

    1. The tradingview scalper is in the link below. Notice that there are way too many signals than necessary because of the settings, but do remember that the free account has a delay on the globex futures symbol but the signals are still valuable in spotting what is working as day trades – do not trade the signals as is. A trader should set up their own free or paid account to better use the service.

      https://www.tradingview.com/chart/b8PRVEvd/

    2. Breakdown.

      I took no action, and have no plans to take any further action. We’re almost back to the May lows, which I felt even back then was a decent entry point for the longer term. So I’m good.

    3. Probably just dreaming here, but a low inflation print could spark a +5% rally.

    1. Silver lining would be a capitulatory hammer that finally launches the next rally.

    2. One thing I find helpful during selloffs is to compare my investment assets to a home. Home prices can and have swung dramatically – yet I pay almost no attention to the swings, knowing that it’s all part of owning an asset. Why view investments in stocks/bonds any differently? When the stock market eventually recovers and rallies hard, that’s when I shift my perspective – it’s entirely possible to sell stocks/bonds at the highs.

  9. $SPX 3901 was the closing price of 5/20/22 where this ralley began and price is taking a pause here after blowing by couple of pivots and VWAPs. A VWAP at 3868 is the next stop down and of course you have the pivot low of 3808 seen on 5/20/22.

    The bulls really cut and run on this one but studying the up volume of the indices and incorporate that into a price structure may make some sense of the market structure. A more observant trader than I could have seen this coming where the up volume just mostly disappeared at the support levels. The following chart shows the microstructure of the 30 minute bar with price and types of up/dn volume arrows and price breaks where trades could have been placed.

    https://ibi.sandisk.com/action/share/89776cb0-b782-4c8a-a0b5-449f722df8e3

  10. Cam- How has the 40/60 portfolio (40% SPY/ 60% IEF) performed relative to the 60/40 portfolio YTD? I’m wondering if 2022 might the first year that the traditional conservative approach will actually underperform the 60/40 against the backdrop of a bear market.

  11. How does it feel to begin a buy-and-hold approach the week before the market sells off -5%?

    The initial reaction is ‘not that good.’ That’s first level thinking.

    Second level thinking leads to the opposite conclusion – at least for someone with my personality. Given that any journey comes with ups and downs – I’m the kind of guy who prefers to get hit with the worst the journey has to offer in the beginning. If markets need to retest or even exceed the May lows – let it happen at the get-go.

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