Market Analysis

Back Test

Having fun yet? Worst H1 start to a year since 1932. A macro picture as complex as we’ve seen in all our lifetimes and central bankers stumbling to fix their mistakes of the past while at risk of making more policy mistakes as we speak.

But this article is not about macro, but rather it’s a KISS article, keep it simple stupid, and this is where technicals can help in giving context to all that has happened.

In its simplest form at the time of the sell case at the beginning of the year $SPX was vastly disconnected from its yearly 5 EMA:

This current bear market had a 3600 target on its back even then:

Reaching the low 3600’s last week we can observe that $SPX has simply reconnected with the yearly 5EMA:

After the excess of last year it was due to do just that.

The same applies for the tech sector:

In this sense the great unwind for the first half of the year has accomplished a technical base line: Rebalancing.

Now, as you can clearly see major bear markets of the past have seen dramatic spikes below the yearly 5 EMA, but these structural bear markets (crashes aside) also didn’t move in a straight line. Rather big awe-inspiring bear market rallies were part of the equation. Why? Because markets don’t like imbalances and when they get too far disconnected from key balance points they tend to create counter moves.

We’ve seen some of these this year in the form of up to 12% counter rallies, most notably back in May following the What If trifecta considerations of rates, dollars and junk which all cooperated for such a bear market rally.

In June all trifecta components then turned again and went to new extremes and equities dropped to new lows as a result creating further imbalances. But not only that, we now can observe key back tests.

One I highlighted on my public Twitter feed at the current lows of last week:

Technicals do matter and we can assess this as an area of confluence support as indeed we have seen an upside reaction since then:

Revisiting the pre Covid highs can be considered a back test along with the yearly 5EMA reconnect.

Ironically it is not only the broader $NYSE index that has backtested its pre Covid highs, but also the Dow Jones Global index:

This offers a perspective of congruence and confluence.

None of this implies that the cycle lows are in, but it informs of the possibility of a sizable bear market rally.

Let’s not forget how much this market has been punched in the gut. There are many indicators that suggest we are at historic extremes, not as extreme as the GFC perhaps but still impressively low. For example: Last week there where only 7 $NDX components above their 200 day moving average with a weekly close at 8:

A reading lower then during the Covid crash.

These readings appearing as $NDX is in proximity of its weekly 200MA.

Hence I made a call for a larger bear market rally to be a distinct possibility last Friday with eyes wide open to further risks:

Specifically what I referred to was lows coming either from the lows last week or with still some risk margin into the weekly 200MA:

Note the weekly 200MA proximity was where the Covid lows took hold, but perhaps more importantly it was the point from which markets launched a larger bear market rally in 2008 reconnecting with the weekly 50MA into a .618 fib retrace.

It was only after that reconnect that the real market damage came about as the global financial crisis unfolded. At this time nobody can attest with certainty how the macro picture will ultimately unfold. Too much is dependent on future data developments.

I submit technically we have now seen key technical reconnects, we have seen key back tests and points of confluence & congruence all of which are suggestive of a larger technical counter rally to come, either from last week’s lows or after a tag of the weekly 200MA.

Can I be wrong about this? Certainly, technicals don’t give us guarantees, but they help assess risk/reward and probabilities. Furthermore I think we all need to be humble about the possibilities and one of the biggest risk factors in my eye is now again a Fed that, at least publicly, appears in denial about the true state of the economy with its Chair insisting on how strong the economy is while it is in fact slowing down rapidly.

All I can tell you this: If the Fed is indeed intent on raising rates to a 3.8% Fed funds rate as their dot plot suggests we’ll won’t see a soft landing:

I suppose the only comfort here is that not a single dot plot the Fed has ever put out has come to fruition.

As last year, by insisting on running run ultra loose monetary policy into a rapidly inflationary environment exacerbated by record fiscal stimulus that it tried to label as transitory, the Fed, self admittedly not being able to solve energy and food price inflation with rate hikes, is again risking to be the danger by making things worse by aggressively hiking into a rapid slowdown with the largest cheap money based debt construct in history as its backdrop.

My take here: The key decision point will ultimate come after a larger bear market rally. If inflation shows solid reversals this summer allowing the Fed to pivot or pause we may have come to realize that the H1 stock drama may have been a key low, if not, then the bear market rally, alleviating extreme imbalances and signals, may serve as another selling opportunity with this bear market producing new structural lows. We will need to keep assessing the evolving technical and macro picture as the journey unfolds.

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Categories: Market Analysis

3 replies »

  1. Yes and no, Sven. Yes there will be a bounce, no it won’t be sizable. There’s a good chance we’ll top 4000 (ES00, currently 3780) in next few weeks but low probability of exceeding 4200 before we go down to 3600 and below. How low then it’s too early to say but my long term target of 1800 will become a distinct possibility in next couple of years.

    I think there is this conundrum: to avoid the market seriously cratering the Fed will need to pause rate hikes and/or QT, possibly restart QE, within 6 to 12 months from now. Doing so trashes what little is left of their credibility and may even lead to their demise. All the Fed ‘tools’ (and I’m speaking about them as persons) are barely beginning to perceive the horrors they’ve unleashed by their tardy wimpishness. When and if they come to that full realisation I’m not so sure how they will react.

    Will Jay keep taking the blue pills and doling them out willy-nilly to all and sundry? Stay tuned for the next episode in the M&P saga coming soon to this channel…

  2. THANKS for this superb review of the electronic casino, which is run by the algos and all the trading platforms. Especially the robots tucked in as nano second electronically close to the futures in Chicago as they could get them so they could front run the market moves, and thus each other?
    Perhaps why the FED opened their second trading office there to get tucked into the nano second action with their robots??
    The quote at the end of the movie “War” comes to mind: “The only way to win is not to play.”

  3. MrMarket: Hey Jay, you’re not listening still (perhaps he never will)
    JayPowell: Howzat M?
    M: Your inner Volcker, J, you gotta listen harder
    J: Well we did 0.75%, M, what more did you want?
    M: Some shock and awe, prove you’re serious about curbing inflation
    J: What might that look like M?
    M: Well, last meet +1.5%, and sell all the MBS shit pronto…
    M: …and don’t water it down with all your weasel words like you keep doing
    J: That would be painful M
    M: There’s gonna be pain, accept that, embrace it, go through it
    J: Hmmm
    M: Like I said before, small pain now better than big pain later
    J: What do you suggest, M?
    M: Take the red pill
    J: Eh? As in Morpheus and the multicolored gymslip?
    M: LOL, kinda. You’ve been living in an illusion, most of the rest of the FOMC and markets, too
    J: Why do you think that M?
    M: ‘Cos I took the red pill about 15 years ago
    J: You’ve kept very quiet about that M, why so?
    M: Well, I was doing very nicely outta the illusion
    J: Why stop now?
    M: It’s gonna break before long if we carry on like this, then it all goes pooff
    J: What’s pooff?
    M: As in The Simpsons “And… it’s gone, all gone”, the whole damn kaboodle, all YOUR money
    J: Ouch, that would hurt
    M: If you keep taking the blue pills you probably won’t care, here’s a bucket of them
    J: What’s in the little jar?
    M: Them’s the red pills, I have to be really careful with them
    J: And you think I should take one?
    M: If you are brave enough to see reality as it truly is, but be warned: there is no going back
    J: Is it safe?
    M: No, nothing is really safe, like interest rates at 0%, QE… but hey, I survived it no prob
    J: OK, I’ll think about it, gimme one
    M: One last suggestion, before you take the red pill it would help you to read a book…
    M: “The Futurological Congress” by Stanislaw Lem, it will sorta explain the effects in advance
    J: OK M, will do
    M: Good luck J, be seeing you


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