Mid-week market update: The stock market surged last week in reaction to the soft CPI reading. It got better news this week when PPI came in lower than expected. As well, China unveiled a 16-point package to try and stabilize its cratering property market and softened some of its Zero COVID policies. Berkshire Hathaway unveiled a new long position in TSMC, which light a fire under semiconductor stocks, though Micron’s warning this morning unwound some of the rally.
As a consequence, the Investors Intelligence survey showed that the bull-bear spread turned positive. Increasingly, I am seeing discussions about positioning for a year-end rally.
Should you jump on the year-end rally bandwagon?
A year of the Grinch
While the year-end rally is becoming the consensus view, I beg to differ. Beneath the hood, signs of technical deterioration are appearing that are causing some concern. 2022 is likely to be a year of the Grinch for equity investors, instead of Santa Claus.
Despite all of the good news, the S&P 500 is struggling to overcome resistance at the 4000 level. Should it stage an upside breakout, the next major resistance level is at about 4120 at the falling trend line resistance.
The NYSE McClellan Oscillator (NYMO) is exhibiting a negative divergence while overbought. While this is not a precise market timing indicator, it is nevertheless an ominous development.
The NYSE McClellan Summation Index (NYSI) recycled from an extreme oversold condition of under -1000. Past rallies have usually taken NYSI back to positive – and it’s nearly there. The one exception was the bear market rally of 2008 when NYSI rose to -200 before weakening. The current reading is above the -200 minimum level, indicating that stock prices could fall at any time during this bear market rally.
The 10 dma of the CBOE put/call ratio has fallen to levels that indicate complacency is setting in, which is contrarian bearish.
A short covering rally
The violent price surge off the CPI report can mainly be attributable to short covering. SocGen found that last Thursday’s big winners have been the worst losers in 2022.
In addition, anecdotal evidence indicates that a number of long/short equity hedge fund strategies were recently shut down. This necessitated a massive bout of short covering, as evidenced by the reversal in all flavors of the price momentum factor. In order for the rally to continue, the bulls need to exhibit further momentum. In this context, the failure of the S&P 500 at 4000 is disappointing.
Investors are probably familiar with the analysis of mid-term election year seasonality, which states that the stock market tends to enjoy a bullish tailwind into year-end. Callum Thomas at TopDown Charts
analyzed mid-term election year seasonality by bull and bear markets and found that the S&P 500 tends to decline into year-end during bear markets.
The moral of this story is, “Beware the facile analysis of seasonality”. The weakness during bear markets makes sense, as stock prices will be pressured by tax-loss selling as December approaches.
In conclusion, don’t be fooled by the talk of a year-end rally. The market rally is poised to stall in the near future. Even though I don’t have an actionable sell signal for traders, investors should stay cautious.