At the outset of every month, we take a top-down look at the US equity markets and ask ourselves: Do we want to own more stocks or less? Should we be erring toward buying or selling?
That question sets the stage for everything else we’re doing. If our big picture view says that stocks are trending higher, we’re going to be focusing our attention on favorable setups in the sectors that are most apt to lead us higher. We won’t waste time looking for short ideas – those are less likely to work when markets are trending higher. We still monitor the risks and conditions that would invalidate our thesis, but in clear uptrends, the market is innocent until proven guilty. One or two bearish signals can’t keep us on the sidelines.
Similarly, when stocks are trending down, we aren’t looking to buy every upside breakout we see. We can look for those short opportunities instead, or look for setups in other asset classes.
So which is it today? Are we looking for stocks to buy or stocks to sell?
The S&P 500 index fell by more than 2% last week, bringing the total decline to more than 10% since stock prices peaked in late July. The Dow Jones Industrial Average is now solidly in negative territory for the year, and even the NASDAQ Composite’s 20% gain looks modest compared to the near-40% mark set earlier this year. Interest rates stabilized during the week after the 10 Year Treasury yield briefly touched 5%, and the US Dollar Index continued to mark time as it has since the end of September. Gold gained more than 1% for the third straight week, but Bitcoin stole the show when it jumped by nearly 20% and reached its highest level in more than a year.
Preliminary data indicated that third quarter economic activity was strong, and the first estimate of GDP lived up to the hype. The economy grew at a 4.9% annualized rate in 3Q 2023, among the best prints over the last 20 years.
At this week’s FOMC meeting, Jerome Powell & Co. will have to decide whether the economic acceleration is consistent with their price stability mandate. Almost no one believes they’ll raise rates on Wednesday (futures markets are pricing in a 0.0% chance as of this writing), but the post-meeting press conference could give us additional clues as to how Fed members see the path of rates in 2024. Or not. After their meeting last week, European Central Bank head Christine Lagarde stressed that now is not the time to be giving forward guidance, given the uncertainty of the outlook.
What is it that drives prices in the markets? Is it intrinsic value? The present value of future cash flows, the pace of earnings acceleration, dividend and buyback policies? Is it economic growth, interest rates, or manufacturing activity?
Each of these plays an important role in building an investment outlook, but the truth is, they don’t make prices move. Not directly. The reality is more simple than that. Prices move based on changes in supply and demand, or put another way, on peoples’ decisions to buy or sell securities.
People do their best to incorporate all those important, fundamental components into their buy/sell decisions, but human behavior is a funny thing. We’re susceptible to psychological flaws, and even when we know those flaws exist, we’re not good at correcting them.
Over long enough time horizons, asset prices do tend reflect their intrinsic values. If you overlay the S&P 500 index with its annual earnings per share over the long term, you’d be hard pressed to tell which was which. The logical thing, then, would be for humans to make buy or sell decisions solely upon the intrinsic value of an asset. And people know that’s what they’re supposed to do – there are a million books written about the subject. But people don’t do what they’re supposed to do. Emotions get in the way. There are plenty of books written about that, too.
Technical analysis, at its core, is really a study of human behavior. And human behavior reacts to prices it remembers by buying or selling. That’s the foundation of what technicians call ‘support’ and ‘resistance’.
So what does that mean for the market today?
The US stock market peaked back in early 2022, then embarked on the most extended decline since the 2008 financial crisis. Undoubtedly, many investors looked at their dwindling account values and thought, “If only I had sold back in January. If I could just get back to where I was…”
Those are the types of emotions often drive investment decisions, and we see the result when prices react to former highs and lows. When prices approach a level that once marked a significant bottom, investors that missed out the first time around are inclined to buy so they don’t miss out again. This demand for shares is called support. And when the opportunity comes again for those who wish they’d sold at a former peak, they’re inclined to take advantage by supplying shares, something we refer to as resistance.
Of course, the emotions that investors experience are more complex than that and there are millions of other factors at play. But we still see the importance that former turning points have on market action.
And Information Technology is still trying to absorb overhead supply.
Let’s be clear about where the sector stands. Prices are above their long-term moving average, RSI momentum is in a bullish range, and we’re much closer to 52-week highs than 52-week lows. This is absolutely not a downtrend. If this decline extends further and momentum drops into oversold territory, that’s a different story. But that’s not the story today.
So if Tech isn’t in a downtrend, it’s either in an uptrend or a sideways range.
Those highs from almost two years ago are our line in the sand. If Tech is above that line, there’s absolutely no reason to be bearish the sector, and, given Tech’s weight in the benchmark S&P 500 index, not much reason to be bearish on stocks overall.
Since we’re below that line, though, it’s best to take a more cautious and selective approach to the group.
Especially since breadth in the sector isn’t as strong as the index-level price chart appears. The equal weight Tech sector has fallen below support and is now stuck back within the trading range that endured from April 2022-May 2023.
A rapid recovery in the EW sector above that area of support-turned-resistance would turn us incrementally bullish on Tech.
Seasonality is a tailwind, but that hasn’t mattered much lately. Historically, October is among the best months for Tech, yet the sector has dropped about 2.4% this month. Often, seasonality offers the best information in hindsight. If stocks are weak during a seasonally strong period, that tells us how weak things really are.
On the other hand, Tech is outperforming the S&P 500 index for the month, which is confirming historical seasonal patterns.
The relative strength over the past few weeks has pushed Tech back to the top of the year-to-date S&P 500 sector leaderboard, but it hasn’t been enough to spur a relative breakout. The ratio of Tech to the SPX is rangebound as it digests the run-up from the first half of the year.
Similarly, rangebound is the ratio of Tech to the SPX on an equally weighted basis. This ratio isn’t in a downtrend, but we shouldn’t be betting aggressively on Tech outperformance as long as were below the highs of this 3-year range.
Digging Deeper
The good are getting less good and the bad are getting worse.
Most of the equity market peaked in late July and sold off throughout the months of August and September. Communications, meanwhile, continued to hover near its highs, up more than 40% for the year. October was more of the same, with the sector even managing to touch new 52-week highs on the 11th.
Stocks are selling off for the third straight month, and with interest rates on the rise, bonds aren’t offering the safe haven that we’ve grown accustomed to over the last 30 years. Maybe it’s time to find somewhere else to hide.
The green shoots that sprouted at the beginning of October are nowhere to be found. The S&P 500 index dropped 2.4% last week, falling to its lowest level since the first of June. The Dow Jones Industrial Average outperformed for the week, falling only 1.6%, but that decline was enough to erase the Dow’s entire year-to-date gain. Interest rates continued to rise, with the 10-Year Treasury yield approaching 10%, and benchmark mortgage rates climbing above 8%. Commodities offered investors a haven, as crude oil prices rose 1.2% and gold prices rose 2.5%.
Futures markets are pricing in almost no chance of another interest rate hike at the November FOMC meeting. That comes after Fed Chair Jerome Powell spoke last week, reinforcing the Fed’s resolve to control inflation, but acknowledging the impact that higher long-term interest rates are having on financial conditions. Powell also repeated an oft-mentioned belief: it will likely take a period of below trend economic growth for inflation to reach the Fed’s 2% target. Below trend growth, however, is not what we got in Q3. Retail sales accelerated in September, reaching a 3.8% year-over-year rate, the highest since February. That drove an upward revision to the Atlanta Fed’s estimate for third quarter GDP, which now stands at 5.4%. That would be the fastest rate of growth since the end of 2021, when we were still rebounding from the COVID shutdowns. We’ll get our first official read on third quarter growth this week.
Reports of the death of the US consumer have been greatly exaggerated.
This morning, the US Census Bureau released their advance estimate for September Retail Sales. The number blew past expectations, coming in 0.7% higher than sales in August, which were also revised higher. On a year-over-year basis, retail and food services sales accelerated to 3.8%.
Just a few short weeks ago, the consensus view on Wall Street was that the US consumer was set for a major slowdown. Layoff announcements had been on the rise since the beginning of the year, wage growth was slowing, and student loan payments were set to resume in October. On top of it all, everyone agreed that excess savings from the pandemic – when direct checks from the government caused personal incomes to spike at an unprecedented rate – were drying up. An August paper from the San Francisco Federal Reserve estimated that excess savings had been entirely spent.
The S&P 500 index rose for the second straight week, despite steep intraday selloffs on both Thursday and Friday. Interest rates fell sharply to start the week, with the 10-Year Treasury dropping from the previous Friday’s high of 4.9% to just 4.5%. However, Thursday morning’s hotter than expected inflation report marked the trough, and rates ended the week above 4.6%. Commodities were the big winners, as Gold prices surged 5.5% and oil jumped 5.9%.
One year ago, CPI inflation was at 8.2% per year, just off its highs. At the same time, though, inflation excluding the cost of housing, was dropping below 2% on a 3-month annualized basis. Housing costs matter, of course, but the government’s method for measuring housing costs notoriously lags the real-world experience. So when this pared-back measure of inflation reached the Federal Reserve’s target, equity markets responded by putting in their bear market lows. Today, the ex-housing measure has fallen perfectly to the Fed’s target – it’s at 1.98% over the past year. The shorter-term measure, however, is showing signs of reacceleration – it’s back up to 4.5%
Energy prices are to blame for the reversal. The cost of energy has jumped at an annualized rate of more than 30% over the past quarter.
Our job as technicians is to find trends, with the belief that trends are more likely to persist than reverse course.
One of the easiest ways to identify those trends is to look at a stock’s current price and compare it to the level and direction of a moving average of trailing prices. If the current price is above a rising moving average (MA), then prices are in an uptrend. Below a falling MA, a downtrend. Pretty simple, right?
Things are a little more difficult when you get mixed signals: the level says one thing, but the MA trend says another. What if price is above a falling MA? That’s key first step toward a new uptrend, but it doesn’t always mean prices have bottomed. The same logic holds for a price that’s below a rising MA.
So what do you call it when prices are directly on top of a flat moving average? In this case, we call it Health Care.
