Investment Research
The Grindstone Intelligence Sector Outlook is based on our top-down technical approach. These ratings reflect our views over the coming month.
The Grindstone Intelligence Sector Outlook is based on our top-down technical approach. These ratings are based on our views over the next coming month.
The first quarter of 2023 stands in stark contrast to the lived experience of 2022. Last year, stocks were ravaged by a valuation-led bear market, bonds had their worst year in memory, and inflation cut into already poor nominal returns. We’re only three months in, but the growth-oriented NASDAQ has already jumped more than 16%, the S&P 500 is up 7%, and bond prices are rising. So is the bear market firmly in the rearview mirror?
Each month we take a top-down look at the US financial markets and ask ourselves: Is this a time to buying stocks and increasing our exposure to risk? Or are we better served looking for stocks to sell and finding alternative places to invest?
For most of this year, we’ve been reluctant to answer that question with any conviction. On one hand, indexes are well off their October lows, and the rally has lasted longer and risen further than what is typically seen during bear market rallies. On the other hand, the largest US stock indexes remain stuck below key overhead resistance. And while the list of stocks hitting new 52 week lows peaked last summer, we’ve yet to see a resurgence in the list of stocks setting new highs.
The S&P 500 is trying to get through the 4100-4200 level for the fifth time. This has been our line in the sand all year, and there’s no reason to change that approach now. It’s the 161.8% retracement from the 2020 decline, and it also marked a key low early last year, before the bear market really got going. It’s been resistance for 10 months.
If the S&P is above its February highs, we’ll have much more confidence that this is indeed a new bull market.
The same goes for the NASDAQ. The resistance area we’re watching here is from 11800-12200. These aren’t just numbers we’re pulling out of a hat – 12000 is the 161.8% Fibonacci retracement from the entire COVID selloff. The market respects these Fib levels, so we do, too.
But it’s not just weird rabbit math that has us watching that level. It’s also where growth stocks peaked relative to value. In September 2020, growth stocks – which dominate the NASDAQ – ended a near 15-year run of outperformance relative to value.
Another strong week like the last, and both of those indexes will be above our key levels. In that scenario, where could prove our bullish thesis wrong? Weak breadth.
Most stocks have lagged index returns so far this year, and by a wide margin. The equally weighted S&P 500 has underperformed the cap weighted index by 6% since mid-January.
That’s not entirely unusual. It just means the biggest stocks (which all happen to be growth stocks) are rising faster than smaller ones, and we already knew that growth was driving this year’s returns. Outside of growth names, though, the trends are far from awe-inspiring. The NYSE Composite was setting new 3-month lows just a few short weeks ago, and momentum is in a bearish range.
But a lack of upside participation is different from outright negative leadership. Last month, we lamented the weakness in the Dow Jones Industrial Average and said prices needed to get back above 33000 in a hurry. They did just that:
The Russell 2000 tested its bear market lows. But it held those lows.
We favor a neutral approach to equities unless the S&P 500 is above 4200 and the NASDAQ has comfortably cleared 12200. In that scenario we need to be positioned for higher stock prices. That doesn’t mean we need to be indiscriminately buying everything we see – we still want to be selective. But unless the situation in value deteriorates further, there just isn’t much technical evidence to support a bearish approach.
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February lived up to its reputation as one of the worst months of the year. Since the inception of the S&P 500 Index in 1950, stocks have averaged a negative return during the month. Only September has a worse track record. This year, stocks followed their seasonal pattern, as the S&P 500 dropped 2.6%, the Dow Jones Industrial Average fell 4.2%, and the NASDAQ Composite fell just more than 1%. Let’s take a look at how things are shaping up for March.
Each month, we start our journey from the top, looking at the market from 30,000 feet up and focusing only on the biggest indexes. In just a handful of charts, we can see exactly the type of investment environment we’re in. Are stock prices rising or are they falling? Should we be erring on the side of buying or selling stocks?
Last month, our view was that stocks had made significant progress toward ending the bear market that began in 2022. Here’s how we put it:
We aren’t out of the woods yet, but we think we see the light at the edge of the forest.
The beauty of technical analysis is that prices offer us clear risk levels – we know exactly where we’re right and where we’re wrong. We entered the month with a clear view of what we needed to keep an eye on:
Small Caps are the ones to watch. With the last few days of gains, the Russell 2000 is above its own key area of resistance. That’s a good sign – small caps were the first to find a bottom last year and could very well lead us higher in 2023. But if IWM is back below 190, expect the rest of the major US indexes to be failing, too.
Well, the IWM fell back below 190. And the rest of the major indexes fell, too.
(Editor’s note: If you’re having trouble seeing any chart in this report, click on it to view a larger version)
We still aren’t out of the woods.
For months, we’ve been talking about resistance near 4100 for the S&P 500. That was our line in the sand – if prices were above that, we wanted to be buying stocks. If they weren’t, we believed a cautious approach was more appropriate.
Nothing changed during February. Stocks failed once again at 4100, and the bears still have the upper hand.
It’s the exact same situation for the NASDAQ. The level here is 12000.
These aren’t just numbers we’re pulling out of a hat. 12000 is the 161.8% Fibonacci retracement from the entire COVID selloff. The market respects these Fib levels, so we do, too.
But it’s not just weird rabbit math that has us watching that level. It’s also where growth stocks peaked relative to value. In September 2020, growth stocks ended a near 15-year run of outperformance. The NASDAQ, which is dominated by those same growth names, is paying attention.
There’s no reason to be aggressively buying stocks as long as we’re below those key levels. We know exactly where we want to be more bullish. So what would it take for us to shift from neutral to outright bearish on US stocks?
We’d need to see more indexes acting like the Dow.
The Dow Jones Industrial Average did more than just fail at overhead supply during February: it ended the month by breaking its December lows. This chart is the biggest threat to the bull case for stocks. If the index that’s been the leader for more than a year is now setting new lows, how can we be buying stocks?
The Dow needs to get back above 33000 in a hurry. If it does, that failed breakdown could be the catalyst that sends prices through that tough overhead resistance near 34500. The longer we’re below 33000, though, the more likely it is that stock prices overall will retest their October lows.
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Stocks got off to one of their best starts ever in January. With every passing day, the climb looks less like a bear market rally and more like the start of a new bullish era. We aren’t out of the woods yet, but we think we see the light at the edge of the forest.
We start our monthly technical outlooks at the top for a reason. In just a handful of charts, we can see exactly the type of investment environment we’re in. Are stock prices rising or are they falling? Should we be erring on the side of buying or selling stocks?
Last month, we had this to say about the world’s most important stock index:
The S&P 500, a market cap-weighted index comprised of 500 of the biggest companies in the United States, is stuck below a falling 200-day moving average. At best, prices are stuck in a sideways trend. The line in the sand for the SPX is 4100. That’s the 161.8% Fibonacci retracement from the entire COVID selloff, and that’s been overhead resistance since May. If we’re above that, we’ll be looking for stocks to buy. As long as we’re below it, we need to err towards caution.
Since then, the index has surpassed its 200-day. That’s one point for the bulls. But we haven’t surpassed the resistance area near 4100. The bears have the upper hand unless and until that level is taken out.
(Editor’s note: If you’re having trouble seeing any chart in this report, click on it to view a larger version)
We’re watching closely, because a few more days like the last would quickly push us above it and give us confidence to flip from a neutral stance to one that’s more bullish overall. Remember, our goal is not to nail tops or bottoms, but to catch the middles of big trends. IF this is truly the start of a new, multi-year bull market, we can afford to wait for that confirmation.
It’s the exact same situation for the Dow and the Nasdaq. The Dow Jones Industrial Average has so far been unable to absorb all this overhead supply between 34000 and 35000. It wouldn’t take much to get a breakout, but this editor is from Missouri. It’s gotta show me.
The level for the NASDAQ is 12000. That’s the 161.8% retracement from the 2020 selloff and the September 2020 peak, which marked the beginning of a regime shift as value stocks took the lead from growth. If the NASDAQ is above 12000, we can confidently be buying stocks.
Small Caps are the ones to watch. With the last few days of gains, the Russell 2000 is above its own key area of resistance. That’s a good sign – small caps were the first to find a bottom last year and could very well lead us higher in 2023. But if IWM is back below 190, expect the rest of the major US indexes to be failing, too.
The start of 2023 has brought about a shift in market leadership. As such, we’re making the following changes to our sector ratings and updating our US Equity Model Portfolio to reflect those changes.
We can finally put one of the worst years for investors in the rearview mirror. In 2022, both stocks and bonds came under pressure, something we’ve rarely seen since the 40-year bull market in bonds began in the early 1980s. Will 2023 be any different? January will set the tone, so let’s see how things are shaping up.
We start our monthly technical outlooks at the top for a reason. In just a handful of charts, we can see exactly the type of investment environment we’re in. Are stock prices rising or are they falling? Should we be erring on the side of buying or selling stocks?
In that respect, nothing has changed since we wrote our December outlook: US stocks are NOT in an uptrend. The S&P 500, a market cap-weighted index comprised of 500 of the biggest companies in the United States, is stuck below a falling 200-day moving average. At best, prices are stuck in a sideways trend.
(Editor’s note: If you’re having trouble seeing any chart in this report, click on it to view a larger version)
The line in the sand for the SPX is 4100. That’s the 161.8% Fibonacci retracement from the entire COVID selloff, and that’s been overhead resistance since May. If we’re above that, we’ll be looking for stocks to buy. As long as we’re below it, we need to err towards caution. A break below 3500 would be even more evidence that bears are still in control.
The Dow Jones Industrial Average was the leader for all of 2022, and there’s no reason to expect that to change any time soon. The Dow is alone among the major indexes in that it’s above its long-term moving average. Still, the DJIA failed to stay above the August peak after rallying above it in November.
We’d turn incrementally more positive with prices back above those swing highs.
The Nasdaq Composite is the least constructive of the major indexes and showed relative weakness for all of 2022. Even if this bear market has run its course, there’s no good reason to be heavily involved from the long side until we get back above 12000. Near-term, a test of 10000 and the pre-COVID highs seems more likely, as December’s selloff nearly pushed prices to new 52-week lows.
Small cap stocks continue to maintain support from the January 2020 highs. The Russell 2000 hasn’t set a new low since the summer.
The 200-day moving average has acted as resistance on each rally since then, though. A neutral approach is best for now on small caps, at least until this range resolves in one direction or the other.
November was a good month for investors, as prices for stocks, bonds, and commodities all rose. After the first three quarters of 2022 had us on pace for one of the worst years ever, it was a welcome reprieve. Have we seen the bottom of this bear market?
The S&P 500 Index closed above its 200-day moving average for the first time since April. It’s now 16% off the October lows, when prices found support at the former September 2020 highs. Still, we remain cautious on the index. The 161.8% retracement from the entire COVID selloff lies at 4140, and it has proved to be a key turning point several times this year. Until the S&P 500 shows it can get above that level and hold it, we have to assume this downtrend remains intact.
The Dow Jones Industrial Average has been the leader, and it’s clearly the best positioned now. The DJIA has surpassed its August highs.
The value-tilted index is now just 7% from setting a new all-time highs.
Bringing up the rear is the Nasdaq Composite, still stuck near the June lows. It’s the least constructive of the major indexes and has shown relative weakness all year. Even if this bear market has run its course, there’s no good reason to be heavily involved from the long side until we get back above 12000.
Small cap stocks found support at their pre-COVID highs, bottoming before any of the other major US indexes. The bounce from those lows has been lackluster, though, and the Russell 2000 has struggled to set a higher high or meaningfully exceed its 200-day moving average.
No matter how dark the fundamental outlook may be, there’s no denying the strength of the recent rally. If prices are our only guide – and for many of you reading this, they are – it seems as though we’re nearing the light at the end of the tunnel.
First things first. This is still a bear market. Prices are below a downward-sloping, long-term moving average. That’s the definition of a downtrend, and we should not be aggressively betting on higher prices, because that runs counter to the primary trend.
Still, there are long opportunities for more agile investors. The index has rallied more than 10% from its lows and there’s another 7% to 4100, the 161.8% extension from the COVID decline. Support is down near 3500, which marked the October bottom and the September 2020 reversal, when Growth stocks peaked relative to Value.
Given the seasonal tailwinds over the next few months, we won’t be surprised to see that 4100 level tested. If we get above there and hold it, we’ll be a lot more constructive on the outlook for returns.
The Dow Jones Industrial Average has been the clear leader, thanks to its relative lack of exposure to places like Information Technology and Communication Services.
It’s already back to the 200-day after rebounding from the pre-COVID highs. For the Dow, it’s the August highs we need to watch. Anything below that should be treated like a bear market rally that’s setting another lower high.
Bringing up the rear is the Nasdaq Composite, still stuck near the June lows. There’s no reason to be involved with this if we can avoid it. It’s the least constructive of the major indexes and has shown relative weakness all year.
Small caps, on the other hand, are showing relative strength. They’re a lot more exposed to areas like Health Care and Financials as opposed to Tech, so as a group they never even broke their June lows. It’s still in a downtrend, but unlike the large cap indexes, this one has shown one clear sign of a reversal – it stopped going down months ago.
It doesn’t take a CMT charter to know that stock prices are in downtrends. Until that changes, we’re better off being underweight US stocks. In fact, we’re better off being underweight just about everything. Bonds are in downtrends. So are most commodities. And cryptos might be the worst of all. Cash has been the only real safe haven – and even that has been gutted by inflation.
The S&P 500 is below 4100 and working on undercutting its June lows.
It’s entirely possible that this is a successful retest of the bottom, but we aren’t really seeing the evidence of that. In fact, breadth measures are saying the opposite. More stocks were setting new 52-week lows last week than they were at the June lows. And more stocks were getting oversold. The Advance-Decline line for both the S&P 500 and the broader NYSE Composite broke to new lows, too. There simply isn’t much evidence to support stocks rallying to new highs from here. If the SPX is back above 4100, then I think the conversation changes. But until then the bias is lower.