First on the psychology front: A classic big bear market rally emerges not only from deeply oversold levels, but also from extremely negative sentiment and positioning. That’s when the market voices keep screaming for more new lows at the lows and then they get their face ripped off as technicals demand their reconnects and shorts are relentlessly forced to cover. In process pessimism leads to optimism and people tend to chase higher prices at the wrong moment when the risk/reward is shifting again as now the voices scream bottom and are calling for new highs to come. I submit this is the process we’ve been witnessing since the June lows.
It’s all part of the standard extended bear market script that none of us are used to anymore after the 14 years of the monetary excess markets have been subject to.
My view in general is to focus more on practically navigating the wide ranges as opposed to making new highs or new low calls for clicks but rather assess risk/reward along the way as the data and charts are evolving.
On the technical front an update:
In mid June I became every vocal about risk/reward shifting in favor of a big bear market rally to come. Among the factors I cited in my June 17 CNBC interview was $BPNDX hitting a really low level of only 7. While cognizant at the time of risk sill being a little lower the view was for next big move to be higher. Much higher.
Indeed $BPNDX has since screamed higher from 7 to 80:
And note the chart is now sporting a negative divergence which is perhaps signaling a shift in risk reward.
Likewise on June 22 I published “BackTest” which highlighted charts falling into key support suggesting a major bounce at least. One such example is the Dow Jones Global index $DJW. This was the chart then:
Here it is updated:
So I submit the big bear market rally case was the right call especially in context of $NDX having just put in the biggest rally of 2022 with a 20% move off the lows:
In Backtest I outlined the historic bear market rally scenario which suggested key moving average reconnects such as the daily 200MAs or weekly 50MAs. On this basis this bear market rally continues to have risk higher.
As a statement of principle: While many now declare the bear market over as $SPX is no longer 20% off the highs I disagree. From my perch a new bull market can’t be declared until these key moving averages are recaptured on a SUSTAINED basis and markets are not anywhere near that confirmation yet.
Indeed take the historic script of the 2000 bubble bursting:
This market then presented a multi year bear market with a recession unfolding that showed multiple big bear market rallies ultimately failing, but not before reason defying squeezes that ended in key resistance points killing the rallies before ultimately rolling over to new lows. Heck, look at the August 2000 rally that got everyone optimistic again before the rug got pulled again in September of that year.
Whether we are in such a phase again is only known in hindsight, but the charts again show us that risk/reward may be shifting in the short term at least.
For one while higher MA reconnects may still be outstanding we can now note that this rally is becoming very much overbought as seen with the stochastic on $NYSI:
Right at the moment when key charts are returning to the scene of the crime, i.e. $AAPL and $SPX are hitting their trend support lines they broke earlier in the year from below:
While pokes above can’t be excluded as a possibility in my view bulls need to technically sustain moves above these lines to verify control. Failure to do so risks a larger reversal of the recent rally, a rally which has by the way greatly benefited from the massive reversal in yields we’ve witnessed in recent weeks. Which brings me to the macro front.
The recent rally has been supported several key factors.
First off and my contention: Markets can’t handle higher yields on a sustained basis. The debt construct is too large. The market sent that message loud and clear with the 10 year peaking at 3.5% in June coinciding with the market lows. The dramatic reversal since then has acted as a relief trigger for technical oversold equities and the subsequent technical break in $TNX which I highlighted in this ongoing thread since the end of June…
— Sven Henrich (@NorthmanTrader) June 29, 2022
… which has now culminated in this sequence of events:
Don’t say I didn’t give you a technical heads up 😉
Bounce off of support & oversold and straight into backtest.
All it took was 3 Fed speakers 😂
— Sven Henrich (@NorthmanTrader) August 2, 2022
While the current rally is driven by relief on the yield front markets are currently ignoring the cause for it: A massive global economic slowdown which is the principle cause in slowing inflation but puts into question the current still seeming permanent high plateau in earnings (yes an Irving Fisher reference):
I must mention the Fed, the gang that can’t shoot straight and is haplessly trying to keep control of its ever shifting narrative. Powell’s “unscripted remarks” following the last Fed meeting sent markets soaring higher on the perception that he’s signaling a slowing in rate hikes and a shift away from the Fed’s intent to raise the Fed funds rate to 3.8% by next year despite them having outlined it as a target just the month before.. If it wasn’t so serious it’d be laughable but all week this week Fed speakers have tried to walk back Powell’s comments to little avail so far as markets kept rallying and with it financial conditions easing moving explicitly counter to the Fed’s stated mission to get inflation under control.
Here now investors are confronted with an interesting dichotomy. Persistent recession denial (although the Bank of England today clearly spelled out a coming year long recession for the UK today), the US Fed keeps insisting on denying a coming recession led by Bullard who literally insists on claiming there won’t be a recession coming while calling for a 3.5%-4% fed funds rate for the end of this year at the same time.
Sorry folks, but that’s just either dishonest or intellectually bankrupt drivel for already the Fed is poking above its historic failure line:
If you insist on going down that path there will be a recession. That’s the dichotomy. The Fed at least should be honest about that. Or the Fed will indeed be forced to flip flop rendering all their talk this year as meaningless as their “transitory” chatter last year. And yes such a flip flop would result in a massive melt up in asset prices even to new highs, but also likely be repeating the policy mistake of the 70’s:
fyi:Following August 1971 the Fed continued to raise rates aggressively which caused another sell off to new lows, but then the Fed cut rates resulting in a massive equity rally, inflation soared again & the Fed was forced to raise rates again even more causing a big bust in ’74. https://t.co/Rbc988LEVI pic.twitter.com/jAEuuaR8E7
— Sven Henrich (@NorthmanTrader) July 29, 2022
The historic reality is that high inflation is aways followed by a recession and then a rate cut cycle with markets not finding their final bottom until the Fed actually starts cutting rates in earnest and the recession nearing an end:
Initial policy mistake of the 70’s aside the history is also clear: The Fed will be forced to raise rates until there is a recession to tame inflation and THEN cut rates even if inflation is still high.
Let’s not forget the big macro cycle script:
First comes the money supply expansion, then comes the inflation, then come the rate hikes, then the recession as demand collapses and reverses inflation, then come the layoffs and then come the rate cuts.
— Sven Henrich (@NorthmanTrader) August 3, 2022
Recession is the solution to high inflation. An ugly truth, but apparently no Fed official has the guts to say this publicly perhaps because we are in a midterm election year or just because they will never admit it for fear of making it a self fulfilling prophecy. And yes, don’t expect officials either in politics or the Fed to publicly admit this. Recession denial is after all a standard Federal Reserve jawboning technique even when the worst recessions ever stare you in the face. I submit nothing’s changed on that front:
How severe an eventual recession will be nobody can say, but any recession, especially a global one will eventually bring earnings lower especially in context of the current tightening cycle barely having commenced. The recent rate hikes have yet still to make it through the system and let’s not kid ourselves, the Fed’s quantitative tightening program has barely even begun with excess still being rampant in the system:
Speaking of excess, while record market cap to GDP extensions were ignored by investors at their peril last year the historic extension in market cap to GDP exceeding over 200% has since seen a dramatic reversal and ironically has so far bottomed where? At the very top of the 2000 tech bubble:
If the peak of the largest bubble prior to the recent bubble is your measuring stick for a lasting bottom feel free, but if this journey evolves into a multi year process then history very much suggests further rebalancing to come especially in context of the monetary base perhaps being the larger arbiter of markets of all:
In 2019 the Fed sent markets into hyper rally mode as the monetary base was still shrinking but they did it first with a flip flop announcement, then rate cuts and an expanding balance sheet which resulted in an increased monetary base. Are we in that phase yet? No.
Fact is markets have been a tracker of the monetary base since mid 2019 and that trend is still down which suggests continued downside risk to markets.
So why are market rallying in the face of an inverted yield curve one of the most reliable indicators signaling a coming recession? Well, the glib answer may simple be that they alway rally right into the recession:
For yield curve inversions happen in advance of the actual recession and this leaves markets with some room to run.
Where does all this leave us in the here and now as all these factors get negotiated through the system?
From my perch risk/reward is shifting at the moment. While the general bear market rally script suggests risk still being higher (i.e. 4200-4300 on $SPX) the immediate overbought readings and signals in context of upcoming key resistance suggest now is not the time for new longs, rather a lightening up of longs and select tightly managed short plays perhaps.
For one note that, as optimism has come back with a vengeance, the $VIX has been crushed for 8 weeks in a row into key support:
This alone suggests potential for some volatility to emerge in the coming weeks, perhaps for some backing and filling of the recent rally which has led to 5 unfilled gaps below on $SPX:
But that recent breakout was impressive and helped fuel the rally. As I’ve said repeatedly in July, bears must prove their case with new lows and so far they have failed miserably. If this is to be a classic bear market rally then bears must produce new lows this year still and that proof remains outstanding.
For now bulls have shown themselves to be in control and bears are getting relentlessly squeezed.
But $SPX is now entering this phase extended and showing negative divergences suggestive of a coming pullback either from here or slightly higher up. How this pullback then evolves we will have to then assess as it progresses. Heck, one could even make a case, and this is completely speculative at this stage, for a coming pullback to form a larger inverse pattern with risk to as low as 3810 for a right shoulder to then target 4700 first before setting the stage for a larger bear market unfolding later in the year into 2023:
Again: Totally speculative and we will need to assess as charts evolve, but it may not be entirely inconsistent with general mid term seasonality:
To the extent this seasonality chart has any validity this year however new lows into September/October can’t be taken off the table as a possibility either but they then also could set up for a buy this year perhaps as the Fed indeed pivots in utter fear under such a scenario if economic data continues to deteriorate dramatically.. The quickest path to rate cuts after all is a recession.
Bottomline: Absolutism and perma anything is a dangerous stance to take during these complex times. And our job is to be as practical, flexible and realistic in assessing shifting risk reward during complex market phases and the advantage of the wide price ranges this market offers.. The macro backdrop and overt Fed language and consequences of both suggest this is all far from over and we’re just at the beginning of a multi year journey which may well produce new lows in due time, but for now the onus is on bears & given current chart constructs they may well make their presence felt over the next couple of months.
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Categories: Market Analysis