Bull-bear battleground at S&P 4200 – Humble Student of the Markets

Mid-week market update: On the weekend, I stated that my base case was the S&P 500 decline would stop at August low support of 4350, but there was a 25% chance that it would test the next trend line support at roughly 4200, or the 200 dma. Now that we are nearing that level, what’s the prognosis?

Compounding oversold

The market has become very oversold. Seth Golden called it a compounding oversold condition consisting over multiple indicators of oversold extremes.

Bespoke revealed that every major ETF in its Trend Analyzer is in extreme oversold territory.

A similar downside stretched reading can be found in my intermediate-term overbought/oversold indicator, consisting of the ratio of stocks above their 50 dma to the ratio above their 150 dma. Historically, such readings have resolved with relief rallies.

It’s not just the technical conditions that scream “bottom”. The current level of the 10 dma of the equity-only put/call ratio have also signaled panics in the last 10 years.

As well, Goldman’s prime brokerage reported that hedge fund positioning is in a crowded short and ranks in the 98th percentile of the last decade.

The bear case

So what could push stock prices lower? First, real bond yields are putting pressure on the equity valuation. The stock market needs a bailout from either falling nominal yields, falling inflation expectations (watch Friday’s PCE report), or rising forecast earnings growth.

Tactically, the stock market continues to face negative seasonality, with a final low in October.

In conclusion, the stock market is obvious under a lot of pressure. Technical and sentiment conditions argue for a near-term bottom at current levels, but valuation continues to be a concern. My inner trader has been averaging into long S&P 500 positions in the past few days. The usual disclaimers apply to my trading positions.

I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.

Disclosure: Long SPXL

4 thoughts on “Bull-bear battleground at S&P 4200”

As we focus on the American market like normal, China and Europe are getting macroeconomically stressed while America is only sentiment stressed.

The US economy is so much stronger that other countries and that is leading to a surge in the dollar. Just think of the cost of oil around the world when the dollar goes up (local currency down) while the price per barrel soars. That acts as a huge tax on global consumers.

We also have the Fed fighting inflation (trying to reduce demand and lower wage gains) while Biden goes to the picket line to support workers going for higher wages. Then he invites technology leaders to the White house to hand out $100 billion to subsidize (as in deficit spending) AI to fight China’s AI. All this leads to stronger economy and offsets the Fed’s high interest rates.

Also remember multinational company’s foreign earnings are hurt by a rising dollar. We could see that hit forward earnings estimates hard soon.

Bond yields are doing Fed’s work. I think the economy cools faster than markets expect, leading to demand slowdown. A period of pain ahead, not withstanding a short term relief rally. Short covering is a powerful force!