Mid-week market update: While I give seasonality only passing importance in trading, it is well known that September is seasonally negative for S&P 500 returns, which Callum Thomas recently documented.
Can the stock market escape the negative seasonal pattern in 2023?
More downside potential
Looking under the hood, market internals are suggestive of further near-term downside potential. The relative performance of selected cyclical industries is breaking down, which is a worrisome development.
The relative performance of small-cap stocks is especially concerning. Both the Russell 2000 and S&P 600 are testing relative support levels. Decisive breaks could be confirmation signals of broad economic weakness.
As well, Treasury yields are rising, which are pressuring equity valuations.
A 3% downdraft?
While this assessment may appear dire, my base case calls for downside potential to about 4350 on the S&P 500. I have highlighted how the 5-week RSI of the S&P 500 became extremely overbought. In the past, such instances have resolved with a correction (check), a relief rally (check), followed by a re-test of the correction lows. In three of the last four cases, the second re-test held at the old lows. The only exception was the COVID Crash of 2020, which was a panic driven by macro fundamentals. If history is any guide, the next corrective low should terminate at about the site of the August low, which is ~4350.
Investors and traders will have to calibrate their positioning depending on their time horizons, pain thresholds, and investment objectives. A downdraft to 4350 represents less than a -3% drawdown from current levels. How concerned are you about such an air pocket and do you think you’re nimble enough to trade such a move?
The latest bogeyman is rising crude price (leading to higher inflation and then more rate hikes, on and on). But the move looks technical, no more than a very simpleton if-then-else algo-driven trend following. China is slowing so the correct narrative should be lower crude price, plus the perception that EV should also reduce the crude demand. But this is an algo-driven market. Things like this happen all the time.
Interesting! So, the Saudis and Russians are attempting to prop up the price with production cuts, while China’s recovery is not up to par. The former can see the weakness in consumption and therefore cutting production.
The question I have is why can’t the algos see it. I’d expect the algos to be swallow, process and analyze a lot more data than this.
I think oil and all other commodities will get more expensive because of inflation and becoming more scarce along with more people wanting them. But this will likely take years. There are lag effects with rising rates and I suspect the same applies to oil.
If the price stays high it will become a drag with time.
One thing the market has done is ignore bad news, ignore rate increases. The old adage is that this is bullish reaction. Until it isn’t of course.
I’m nervous, not going to bet the farm, but I think we get higher prices after the correction is over, and if we make ATHs, if we don’t get euphoria, I will truly be perplexed.