Vulnerable to a setback

Posted by Cam Hui -

Preface: Explaining our market timing models We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.
 

The Trend Asset Allocation Model is an asset allocation model that applies trend-following principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.
 

 

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

 

 

The latest signals of each model are as follows:

  • Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
  • Trend Model signal: Bullish (Last changed from “neutral” on 28-Jul-2023)
  • Trading model: Neutral (Last changed from “bullish” on 29-Aug-2023)*

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.
 

Subscribers can access the latest signal in real time here.

 

 

Mission accomplished

About two weeks ago, I highlighted the severe oversold nature of the stock market and suggested that it was poised for a relief rally. The relief rally duly arrived, and a week ago I set out a number of tripwires for traders to take profits on the tactical rally. All of the tripwires were triggered:
  • The S&P 500 exceeded the 50% retracement of the downdraft.
  • The NYSE McClellan Oscillator (NYMO) reached the zero neutral level.
  • The VIX Index reached its 20 dma. In fact, it blew through the 20 dma to breach its lower Bollinger Band, which is an overbought condition.

 

 

What’s next?

 

 

An unconvincing buy signal 

The usually reliable S&P 500 Intermediate Term Breadth Momentum Oscillator (ITBM) flashed a buy signal when its 14-day RSI recycled from oversold to neutral. In the last five years there were 26 buy signals, 22 were resolved bullishly and four failed. 

 

In this case, I am skeptical of this buy signal. Past failures occurred when the percentage of stocks above their 20 dma were at or near the 60% level, which is the case today.

 

 

These conditions are consistent with the scenario that I previously outlined where the stock market was poised for a relief rally, which has occurred, followed by further market weakness.

 

 

Further downside potential

The weekly chart of the S&P 500 outlines the bearish potential of a correction. The 5-week RSI of the index reached an overbought extreme of 90 in June. The last two times this happened, the market pulled back, rallied and weakened again to a final low. As the weekly stochastic is still on a sell signal when it recycled from overbought to neutral, this is supportive of the case for a similar pullback after the recent relief rally. Strong support can be found at the 4200–4300 zone.

 

 

 

Worrisome divergences

The market is exhibiting worrisome divergences that makes it vulnerable to a setback. 
The top panel of the accompanying chart shows that the NASDAQ 100 is testing a key relative resistance zone compared to the MSCI All-Country World Index (ACWI). The bottom panel shows that the relative performance of the NASDAQ 100 to the S&P 500 had been inversely correlated to 10-year Treasury yields, which makes sense because the growth stocks represented by the NASDAQ 100 have higher duration and therefore higher interest rate sensitivity. The interest rate relationship began to diverge in early 2023 when AI-related plays soared. While the gap between NASDAQ 100 to S&P 500 and 10-year yields has stabilized, the large gap between the two makes U.S. large-cap growth stocks vulnerable to a setback. As these sectors comprise over 40% of the S&P 500, any narrowing of the gap makes the S&P 500 especially vulnerable to a setback.

 

 

For a longer-term perspective, the dark line in this chart shows the NASDAQ 100 normalized for its relative performance to the S&P 500 in a rolling 52-week period. The shaded areas represent oversold episodes which represent long-term buy signals. By contrast, current conditions indicate that NASDAQ stocks are extended and vulnerable to weakness.

 

 

In conclusion, the overbought condition of the market, combined with an unconvincing show of momentum from the ITBM indicator, makes me believe the market has still unfinished business to the downside. In particular, the lack of a bullish reaction to last Thursday’s benign PCE print and non-inflationary but strong NFP report may be a sign of bullish exhaustion. The S&P 500 should find strong support in the 4200–4300 zone should the market correct from current levels.

 

 

A point and figure tour around the world

Posted by Cam Hui -
Sometimes it’s useful to step back and look at the big picture by ignoring the daily or weekly squiggles of the market. One useful technique of filtering out market squiggles is the point and figure (P&F) chart, which StockCharts describes this way:

Point & Figure charts consist of columns of X’s and O’s that represent filtered price movements. X-Columns represent rising prices and O-Columns represent falling prices. Each price box represents a specific value that price must reach to warrant an X or an O. Time is not a factor in P&F charting; these charts evolve as prices move. No movement in price means no change in the P&F chart.

I will be conducting a P&F tour of markets around the world. P&F charts are especially useful to interpret big picture patterns. Measured price objectives can be useful as indications of possible direction, but they have to be taken with a grain of salt.
With that preface, here is the weekly point and figure chart of MSCI All-Country World Index (ACWI) in USD with a 1% box and 3-box reversal. The index is correcting in the context of a recovery from a bear market. The measured price objective of 108.98 is a useful indication of the upside potential of the move.

 

 

Let’s continue this P&F tour around the world.

 

 

America: Both bullish and bearish 

Let’s start with the U.S., which presents a mixed picture. The S&P 500 chart shows a similar constructive pattern of a recovery from a bear as ACWI. The measured target of 6121 indicates considerable long-term upside potential.

 

 

On the other hand, the NASDAQ 100 tells the story of an extended advance. The measured objective of 13303 indicates a deeper correction. As technology stocks have been the global leaders in a pattern that has gone on for years, this argues for U.S. underperformance in the medium term.

 

 

 

Europe: Consolidating

The chart of Dow Jones Europe shows a market that’s consolidating sideways after a bull move. Based purely on P&F analysis, it’s an open question of whether the next move is up or down, but I have more to say on that issue later.

 

 

However, there are some broad differences. Germany is becoming the sick man of Europe. The DAX is showing a similar sideways consolidation pattern, but the measured objective suggests further downside.

 

 

By contrast, the Greek market has been on a tear, though P&F analysis indicates that it’s too extended and due for a move correction. (Yes, that Greece).

 

 

 

Asia: Signs of weakness

Moving to Asia, China’s Shanghai Composite is in a bear market.

 

 

Hong Kong’s Hang Seng Index looks similarly ugly.

 

 

On the other hand, the Japanese market has been on a tear. The Nikkei 300 staged an upside breakout and it’s undergoing a high-level consolidation with a bullish price objective.

 

 

While the Nikkei bull move looks impressive, Japanese stock market strength is masked by Yen weakness. Measured in USD terms, the move looks far less compelling.

 

 

 

 

A nascent commodity bull

For completeness, I analyzed the P&F chart of commodity prices and interest rates. The CRB Index is bottoming with a strong upside measured move objective.

 

 

However, the CRB Index is highly weighted in energy, and oil prices have been recovering. The upside measured objective of Brent crude is $99.50.

 

 

Equally weighted commodity prices, which reduce the strength of oil prices, is undergoing a sideways consolidation and exhibiting a bullish measured move objective.

 

 

When charting interest rates, the analyst shouldn’t use a percentage move as a box size, but a more traditional scaling approach. The P&F chart of the 10-year Treasury yield shows an upside breakout after a long downtrend. The measured upside objective is an astounding 10.7%. This is the part where P&F price objectives should be taken with a grain of salt. While investors can appreciate the upward pressure to bond yields, a 6.3% target sounds astounding.

 

 

Putting it all together, the positive bullish pattern of ACWI, combined with strength in commodity prices and bond yields, tells a story of a global cyclical recovery. 

 

 

The China recovery scenario

However, there are limits to P&F charting as a technique. Recent twin bearish China Economist covers argue for a China turnaround in the near future based on a twin application of the contrarian magazine cover principle. It appears that the problems in the property sector are overshadowing strength in other parts of the economy. The August China’s official PMI showed improvements in sub-indexes for production and market demand. More importantly, new orders returning to growth. As well, CNBC reported that China Beige Book’s survey found consumer spending bounced back in August. The rebound was broad based and evident in all categories, namely apparel, automotive, food, furniture and appliances, and luxury.

 

 

Should the Chinese economy get a second wind, investors can participate with exposure to Asian equities, or even European equities. Historically, the relative performance of MSCI China has been negatively correlated to the relative performance of the S&P 500, but positively correlated in varying degrees to European stocks.

 

 

n conclusion, my P&F tour tells a story of a global cyclical recovery, which should be equity bullish. A contrarian analysis of China suggests that it is poised for a cyclical recovery. Investors can participate in the China rebound theme with exposure to Asian and European equity markets.

 

Is the relief rally over?

Posted by Cam Hui -

Preface: Explaining our market timing models 

We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

 

The Trend Asset Allocation Model is an asset allocation model that applies trend-following *principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

 

 

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

 

 

The latest signals of each model are as follows:

  • Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
  • Trend Model signal: Bullish (Last changed from “neutral” on 28-Jul-2023)
  • Trading model: Bullish (Last changed from “neutral” on 16-Aug-2023)

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.
 

Subscribers can access the latest signal in real time here.

 

 

Sell the news?

Last week, I suggested that the stock market was ripe for a relief rally in the context of a deeper correction. The rally duly arrived. One of the main events was the earnings report from Nvidia, which blew the doors off Street expectations both on sales and earnings. The market reacted with Nvidia failing to hold its overnight gains. More importantly, the Semiconductor Index weakened below a key relative support level.

 

 

Is this a case of buy the rumour, sell the news? What does that mean about the short-term direction for stock prices. Is the relief rally over and a deeper correction about to begin?

 

 

An oversold extreme

I had pointed out that the market was extremely stretched to the downside on the NYSE McClellan Oscillator (NYMO), among other indicators. In the past, such oversold extremes usually resolved in short-term rallies. Upon further analysis of recent similar instances, I found that the rebound usually reached a minimum target of a 50% retracement of the previous downdraft, which translated into a S&P 500 level of 4470, the VIX Index reaching its 20 dma on a closing basis and NYMO reaching at least the neutral level. None of these conditions have been met, though they came close on Wednesday.

 

 

Arguably, the relief rally has further room to run, but the market’s reaction to the strong Nvidia results was unsettling. Were the near misses on the minimum rally targets good enough to call an end to the bounce?

 

 

The bear case

The bear case is easy to make. The bond market began to discount a new rate hike at the October FOMC meeting. Despite this, the stock market rose Friday.

 

 

An examination of breadth indicators tells the story of narrow leadership. When the S&P 500 broke out to a new recovery high in June, only the S&P 500 Advance-Decline Line confirmed the breakout. The NYSE A-D Line, the S&P 400 Mid-cap A-D Line and the S&P 600 Small-cap A-D Line all failed to confirm the breakout.

 

 

Equally disturbing is the lack of participation by small-cap stocks in the relief rally. In fact, the Russell 2000 is testing a key relative support level (bottom panel). 

 

 

 

Sentiment support

On the other hand, sentiment models point to a durable bottom. The NAAIM Exposure Index, which measures the sentiment of RIAs who manage individual investor funds, fell below its 26-week Bollinger Band. This has been a reliable buy signal with an almost perfect track record in the entire history of the NAAIM Exposure Index.

 

 

Option sentiment data confirms the extreme bearish readings, which is contrarian bullish. The 10 dma of the CBOE put/call ratio is at a historically elevated level.

 

 

Where does that leave us? While breadth indicators argue for a deeper correction, that day may not have arrived just yet. Sentiment is too bearish and should put a floor on stock prices in the short term. The relief rally probably has further room to run.

 

My inner trader remains long the S&P 500. The usual caveats 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.

 

Programming note: I am on holiday next week. Unless the market experiences severe volatility, there will be no mid-week update. Regular commentary will resume next weekend.

 

 

Disclosure: Long SPXL

 

The risks to the resilient bull

Posted by Cam Hui -
Ever since the NYSE Composite monthly MACD flashed a long-term buy signal, I have been monitoring the risks to the bull. Past positive MACD crossovers have signaled long-term resilient equity bull markets and such signals have marked durable advances, which are subject to the normal equity risk of minor corrections without significant bearish episodes.

 

 

 

Part of investing is to be continually skeptical and avoid confirmation bias, which is why I have highlighted possible risks that could derail this bull in the past few weeks. I review these risks here, in addition to others that concern me:

 

 

Credit event risk

The July 2023 Senior Loan Officers Opinion Survey on Bank Lending Practices from the Federal Reserve revealed “tighter standards and weaker demand for commercial and industrial (C&I) loans to firms of all sizes over the second quarter” as well as loans in other categories. I was concerned about the rising risk of a disorderly credit event that disrupts markets. Historically, sharp increases in lending standards (blue line) have been correlated with widening credit spreads (red line), which is an indication of risk appetite. More worrisome, the latest weekly data shows that bank credit is continuing to contract.

 

 

S&P downgraded a number of regional banks last week. While the KBW Regional Bank Index retreated on the news, the relative performance of the index remains above a key relative support level. In other words, the regional bank stocks bent, but did not break.

 

 

Instead, credit spreads have been narrowing.  I continue to be concerned about this tail-risk and I am monitoring the situation, but no risks have materialized so far.

 

 

The market is signaling a benign credit environment. One key risk in U.S. commercial real estate (CRE) has been diminishing: The relative performance of selected office REITs, which represents the trouble spot in CRE, has bottomed and turned up.

 

 

What recession?

Historically, recessions have been bull market killers. While every recession has been associated with equity bear markets, not every bear has been associated with a recession. Street estimates of recession risk have been falling, and the Atlanta Fed’s Q3 GDPNow estimate stands at an astounding 5.9%.

 

 

In addition, the Fed’s staff economists have upgraded their forecast from a mild recession in H2 2023 to no recession, according to the minutest of the latest FOMC meeting.

 

The economic forecast prepared by the staff for the July FOMC meeting was stronger than the June projection. Since the emergence of stress in the banking sector in mid-March, indicators of spending and real activity had come in stronger than anticipated; as a result, the staff no longer judged that the economy would enter a mild recession toward the end of the year. However, the staff continued to expect that real GDP growth in 2024 and 2025 would run below their estimate of potential output growth, leading to a small increase in the unemployment rate relative to its current level.

 

One of the recession threats  I highlighted in my past publication is the softening employment picture. Historically, both temp jobs (blue line) and the quits to layoffs ratio (red line) have led the growth in nonfarm payroll (black line). Temp jobs plateaued in mid-2022 and they have been declining. The quits to layoffs ratio made a double peak in Q4 2021 and Q2 2022, and has been falling in a choppy fashion every since.

 

 

The Sahm Rule, as proposed by former Fed economist Claudia Sham, was designed to spot a recession in real time so that lawmakers could respond to the deterioration in economic growth. 

 

 

New Deal democrat (NDD) found that excess initial jobless claims growth (red line) have led Sahm Rule recession signals (blue line). However, there were enough false positive signals that NDD has demanded eight consecutive weeks of elevated initial claim growth before declaring a recession.

 

 

Here is the latest update. The year-over-year growth in 4-week average of initial jobless claims (red line) rose above the key 12.5% recession trigger level for five consecutive weeks but fell back below, which is not enough to call for a recession. I interpret this as a false positive. While U.S. employment is softening, it’s not falling fast enough to trigger a recession.

 

 

 

Could the BoJ crash the market?

I also highlighted the risk of a disorderly global unwind because of a shift in policy from the Bank of Japan (BoJ). The BoJ had been the sole outlier of major central banks when it pursued an ultra-loose monetary policy as its peers were all tightening. Recently, the BoJ signalled a relaxation of its yield curve control policy when it stated it would tolerate a rise in the yield of the 10-year JGB from 50 to 100 basis points. The BoJ added that it reserved the right to intervene should the rise in yields become disorderly.

 

Japan had been a net provider of liquidity to global markets. One fear is that the shift in BoJ policy would diminish the flow of liquidity, which has the potential to spark a risk-off stampede. 
While the 10-year JGB yield (dotted red line) has risen, it did so in lockstep with the 10-year Treasury yield (black line). More importantly, the Japanese Yen has weakened, which would not be consistent with Yen repatriation or even a reduction in liquidity from Japan.

 

 

So far, the tail-risk from Japan of a disorderly unwind in risk appetite has not arisen, but I  continue to monitor the situation.

 

 

China slowdown risk

Finally, I highlighted the risks of China contagion should its economy slow or crash. There have been a number of articles in the popular press about the challenges that China faces (see WSJ: China’s 40-Year Boom Is Over. What Comes Next?, and NY Times: China Is on Edge as Fallout From Its Real Estate Crisis Spreads). Nicholas Lardy of Peterson Institute for International Economics analyzed China’s slowdown and concluded that cyclical fears are overblown.

 

But a careful reading of the present situation does not support the view that China’s growth is now gripped by a severe cyclical downward spiral that will persist for several years…

 

In particular:

 

China’s imports have also weakened, slumping 7.6 percent in the first seven months of 2023, potentially signaling weak domestic demand. But the “decline in nominal import growth was entirely driven by price effects.” In volume terms imports expanded by 1.0 percent compared with a decline of 6.4 percent in the same period last year. Thus, imports in the first half of 2023 are signaling increasing domestic demand.

 

Lardy’s analysis went on to address and debunk fears that households have lost confidence in the economy, the slowdown is depressing wages, China deflation fears and slumping private investment.
In any case, I demonstrated that the relative performance of the S&P to MSCI All-Country World Index (ACWI) 500 is negatively correlated to the relative performance of MSCI China (bottom panel). In other words, U.S. equity markets are largely insulated from China.

 

 

 

What keeps me awake at night

I conclude from my review that none of the risks we highlighted have materialized, though we continue to monitor them. However, the one key risk that keeps me awake at night is rising inflation and the possibility of upward pressure on interest rates. Even though inflation rates have come down, inflation expectations have been edging up, which is likely to make the Fed uncomfortable.

 

 

The 2-year Treasury yield can be thought of as a proxy for market expectations in changes in the Fed Funds rate. Past peaks in the 2-year yield have either been coincidental or led peaks in Fed Funds. With the 2-year at over 5%, it is showing no signs of a major peak. With the S&P 500 trading at a forward P/E of 18.7, upward pressure on interest rates will put pressure on equity valuations and could put a ceiling on potential stock market gains.

 

 

 

In conclusion, the market faces a number of key macro risks that I continue to monitor, but those risks have not materialized to threaten equity markets. However, the threat of rising rates could put pressure on equity valuations and put a ceiling on any potential stock market gains.

 

How far can the relief rally run?

Posted by Cam Hui -
Mid-week market update: I have been calling for a relief rally, followed by a deeper correction (see Why I am both bullish and bearish). The relief rally seems to have arrived as the S&P 500 breached the upper trend line of a falling channel while exhibiting improvements in new 52-week high breadth.

 

 

How far can the rally run?

 

 

Lessons from recent history

Here are some lessons from recent history to consider in setting minimum rally objectives. The NYSE McClellan Oscillator (NYMO) reached an extreme oversold reading last week when it neared the -100 level. The last three times NYMO reached -100, it always staged a relief rally. Each time, the reflex rally retraced at least 50% of the decline. As well, the VIX Index fell to its 20 dma.

 

 

What does that mean in the current instance? A 50% retracement of the decline translates to  roughly 4470, which is just above the 50 dma of the S&P 500 at 4460. The VIX Index just stands above its 20 dma. In other words, there’s a bit of possible upside left when setting a minimum upside objective.

 

 

Sources of volatility

Two key events are sources of near-term volatility. The main event after the close today is the earnings report from Nvdia, which beat expectations. The stock is trading at 44 times sales and option traders went into the report positioned for a bullish outcome.

 

 

Investors will also be closely watching Jerome Powell’s speech at Jackson Hole Friday morning for any hints of shifts in monetary policy. Former Fed economist Claudia Sahm believes that the speech will be big yawner.

 

Powell will strive to be as boring as humanly possible in his speech. He will repeat, some of it word for word, what he said at the last FOMC meeting or last FOMC minutes—which are released three weeks after every meeting…

 

There’s a good reason not to get creative. Powell, as Chair, speaks for the FOMC, not himself. There are two major data releases—employment and CPI inflation—before the next vote in September. Why box the FOMC in when you don’t have to? His speech will be short; we will learn nothing from him if all goes well.

 

If Sahm is right, a non-speech from Powell could spark a risk-on stampede. The bond market had taken fright at the stronger than expected growth figures coming from economic statistics. A boring speech could calm markets and spur bond prices to rise and better valuation support for stock prices.

 

My inner trader is still long the S&P 500, but he is edging towards the exit. The usual caveats 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

 

Why I am both bullish and bearish

Posted by Cam Hui -

Preface: Explaining our market timing models 

We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

 

The Trend Asset Allocation Model is an asset allocation model that applies trend-following principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

 

 

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

 

The latest signals of each model are as follows:

  • Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
  • Trend Model signal: Bullish (Last changed from “neutral” on 28-Jul-2023)
  • Trading model: Bullish (Last changed from “neutral” on 16-Aug-2023)*

Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @humblestudent@toot.community. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.
 

Subscribers can access the latest signal in real time here.

 

 

Bullish and bearish on different time horizons

As the S&P 500 violated its 50 dma but reached an oversold condition on the percentage of stocks above their 20 dma, I am bullish and bearish on stocks, depending on the time frame.

  • Due for a Relief Rally: The market is due for a bounce (1–2-week horizon).
  • A Deeper Correction: There may be unfinished business to the downside once the relief rally is complete (3–6-week horizon).
  • Long-term Bullish: The technical structure of market action points to a longer-term bull trend.
     

 

 

Relief rally ahead

Let’s start with the shortest time frame. The market is sufficiently panicked and oversold that the odds favour a short-term relief rally.
 

The CBOE put/call ratio spiked last week, which is a sign of panic and contrarian bullish.
 

 

Two of the four components of my Bottom Spotting Model flashed buy signals last week. Historically, such conditions have signaled strong risk/reward long entry points for traders. The VIX Index spiked above its upper Bollinger Band, indicating panic, and the NYSE McClellan Oscillator (NYMO) fell below -50, which is an oversold condition.
 

 

The extreme level of the NYMO is especially notable. The indicator closed at -97.7 on Thursday, which is within a hair of the -100 mark. I went back to June 1998 and studied past instances when NYMO fell below -100, which is a rare event as there were only 20 non-overlapping instances when this happened. Median S&P 500 returns were strong after such signals and peaked eight trading days after the signal.
 

To be sure, last Thursday’s NYMO level does not constitute an NYMO signal based on a -100 threshold. But relaxing the test from -100 to -95 yields expands the sample size from 20 to 24 and the return patterns are very similar. I show the study based on a -100 threshold purely because it’s a round number. Regardless of whether the reading was -97.7 or -100, the market was very oversold.
 

 

The market is near a tactical buy signal. A bounce is about to begin soon.

 

 

A deeper correction

While the U.S. equity market appears washed out, oversold and poised for a rebound, the stall in large-cap technology stocks, and AI-related plays in particular, constitutes significant headwinds for the overall stock market. The relative performance of the NASDAQ 100 has historically been inversely correlated to the 10-year Treasury yield, which makes sense because growth stocks have higher duration than the broad market and are therefore more sensitive to changes in interest rates. The NASDAQ 100 began to diverge from the interest rate factor until recently when it violated a key relative support level. Notwithstanding the fact that bond yields are experiencing upward pressure today, the broad market would face substantial headwinds should the NASDAQ 100 close even half the gap shown on the chart. That’s because large-cap growth stocks, which consist of technology, communication services, and Amazon and Tesla within the consumer discretionary sector, represent over 40% of S&P 500 index weight.
 

 

Make no mistake, the AI party is over. One of the most sensitive AI industries is semiconductors, which violated a relative trend line, indicating a loss of momentum.

 

 

 

Here’s another way of visualizing the AI frenzy. Most of the AI-related plays are listed in the U.S. The accompanying chart shows the relative performance of U.S. large-cap value and growth (black line), which has bottomed and only begun to turn up. By contrast, non-U.S. developed market value and growth relative returns (red dotted line) has been soaring since early June.

 

 

The combination of faltering NASDAQ 100 and the outsized weight of large-cap growth within the S&P 500 argues for a deeper pullback once any reflex rally runs its course.
 

 

Long-term bullish

Even though I am concerned about a deeper correction, here’s why I am still long-term bullish. Such corrective action isn’t unusual after the stock market exhibits strong initial price momentum. The accompanying chart shows the history of the S&P 500 and the percentage of stocks above their 50 dma. Historically, a close 90% above their 50 dma after a 20% reading has generally resolved bullishly for stock prices. But the market often pulls back after the 90% reading, sometimes all the way back to the 20% level.
 

 

One mitigating factor that supports the bull case is the relative strength exhibited by cyclical industries. The relative performance of key cyclicals appears constructive, with the exception of semiconductors and transportation stocks. Even then, semiconductors remain in a relative uptrend, and these stocks have shown a stair-step upward pattern in the recent relative advance.
 

 

 

The bull case for transportation stocks is supported by the inverse head and shoulders pattern of the Dow Jones Transportation Average, which is still holding its breakout by its fingernails.

 

 

For a big picture long-term perspective, here is the weekly point and figure chart of the S&P 500 with a 2% box size and a three-box reversal. This doesn’t look like a price pattern that the bulls should be worried about.

 

 

Lastly, take a look at the trajectories of Bitcoin and the ARK Innovation ETF (ARKK) as indicators of the market’s animal spirits and the speculative cycle. Both bottomed out in late 2022 and their rebounds are intact.

 

 

In conclusion, I am bullish and bearish on stocks depending on the time frame. The market is poised for a short-term rebound, but the durability of the rebound is in serious doubt. However, the long-term trend of the market is still bullish. Investors and traders should tailor their trading decisions depending on their own investment horizons and risk preferences.

 

My inner investor is bullish and he has been opportunistically accumulating positions on weakness. My inner trader initiated a long position in the S&P 500 last Wednesday and he has been averaging in on the long side. 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

What are the contagion effects of a China slowdown?

Posted by Cam Hui -
Periodically, the market is rattled by a “China is slowing” narrative. As the accuracy of official Chinese statistics can be doubtful, the real-time market reaction indicates nervousness, but no panic. The performance of the equity markets of China and her major trading partners relative to MSCI All-Country World Index (ACWI) shows that their trends are all flat to down.

 

 

How concerned should investors be about a China slowdown and its contagion effects?
 

 

Assessing the damage

The economic news out of China is certainly concerning. Bloomberg columnist John Authers pointed out that the six-month average of Chinese growth rates in different categories have been significantly decelerating.
 

 

The bad news just keeps on coming. Large Chinese shadow bank Zhongzhi and its affiliate Zhongrong missed payments on several investment products as a result of China’s property slump. The move sparked rare protests in Beijing.

 

The PBOC unexpectedly announced a cut in the medium-term lending rate by 15 basis points, which unsettled markets. What does the PBOC know that the rest of us don’t?
The offshore yuan, or USDCNH rate, has been weakening and briefly breached the 7.35 level. The yuan exchange rate was not helped by the ultra-dovish policies of the BoJ, which weakened the Japanese Yen and created competitive devaluation pressures in Asia.
 

 

 

Not as bad as it sounds

It may not be as bad as it sounds. In a recent podcast, Leland Miller of China Beige Book, which monitors the Chinese economy from a bottom-up basis, argued that the market has over-reacted to the prospect of the Chinese slowdown. There are two elements of the China slowdown story, a cyclical and a structural element. Miller believes that Chinese cyclical growth is better than the market believes, though he allowed that the structural elements are creating long-term headwinds.

 

Consider, as an example, Fathom Consulting’s China Momentum Indicator, which tracks Chinese GDP in a noisy fashion. The bad news is that China is indeed slowing. The good news is growth momentum is exhibiting a series of higher lows.
 

 

Beijing’s announcement that it would stop reporting the youth unemployment rate, which is at about 20% and a record high, illustrates the long-term structural challenges facing the Chinese economy. This NY Times article about China’s skyrocketing youth unemployment provides some context. Young educated graduates simply can’t find jobs, which has led to the “lying flat” movement, or the refusal to pursue a career, or consider leaving the country. In response, Xi Jinping advised the young to “eat bitterness” or to learn to endure hardships.

 

The youth unemployment problem seems curious in light of China’s aging demographics. Birth rates have been dropping and recently fell below the death rate. Why can’t the young find employment in an economy with aging population, which should give rise to strong employment demand?

 

 

The answer is a skills mismatch. There are plenty of low-paying jobs, but a lessened demand for the skilled workers that the Chinese education system is churning out. The NY Times article reported that “a 11.6 million college graduates are entering the work force this year, and one in five young people is unemployed”. The skills mismatch and youth unemployment problem illustrates China’s long-term challenge of transforming its economy from relying on low-cost labour as a source of competitive advantage to higher value-added production, which requires more skilled and educated workers.
 

In the long run, China faces a competitive imperative to migrate up the value chain. Chinese wage rates are already being undercut by its Asian neighbours such as Vietnam and it’s losing its edge in cheap labour costs. As well, the Party has tried to assert greater control over businesses, which as scared away foreign investment. As a consequence of these factors, Foreign Direct Investment has collapsed.

 

 

 

The market reaction

The market fallout from China slowdown fears has been limited. The primary tool for my analysis is the Relative Rotation Graph, or RRG chart, which is a way of depicting the changes in leadership in different groups, such as sectors, countries or regions, or market factors. The charts are organized into four quadrants. The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotate to lagging groups (bottom left), which change to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again.