The Market Mosaic 10.16.22
An unrelenting Fed is ushering the next wave of selling in growth stocks.
Welcome back to The Market Mosaic, where I gauge the stock market’s next move by looking at trends, market internals, and the mood of the crowd. I’ll also highlight one or two trade ideas using this information.
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Also, be sure to check out Mosaic Chart Alerts. It’s a midweek update covering my best chart setups among long and short ideas in the stock market, along with specific levels that would trigger a trade.
Now for this week’s issue…
If you handed me an important economic report before it was released, I still wouldn’t bet on the stock market outcome…especially in this bear market.
The volatile and uncertain market reaction was on full display following the most recent Consumer Price Index. The September inflation figure increased 8.2% compared to last year, which came in hotter than expected.
Here’s the intraday reaction from S&P 500 futures (which trade almost 24 hours a day). After the predicable plunge in prices to bad inflation data, futures rallied for a 5.6% intraday swing.
It’s easy to get caught up in the daily squiggles of the market, especially when the S&P 500 is nearing records for intraday point swings (Thursday was the third most volatile day of the past decade).
That’s why it’s important not to lose sight of the big picture driving stock prices, and the most recent inflation figures only reinforces the pressures facing the stock market.
Here’s why the driving force behind this bear market is unlike any ever seen, and what it means for stock prices.
Picking Up the Pace
Investors are probably now conditioned to think that stock prices have to plummet any time the Federal Reserve starts raising interest rates. After all, this bear market coincided precisely with the Fed’s move to tighten policy.
But historically, that is not always the case. Just look at the three prior rate hiking cycles, like when the Fed started raising rates (the blue line) at the end of 2015. The following two years were incredible for stock gains (the red line).
Coming out of the dot-com bust, the Fed started hiking rates in 2004 and kept going for the next two years. And during that time, the stock market went higher by nearly 30%.
And then there’s the period going into the dot-com bust itself. The central bank quickly raised rates starting in 1994 and left them at high levels for the next seven years. But as we know, that period unleashed one of the most epic bull markets ever seen!
So why has the negative reaction in stocks been so sudden and severe this time around? It’s all about the pace of rate hikes…or the rate of change.
The chart below (from Bianco Research) shows what separates this cycle from the others. It shows the three-month change in policy rates from major central banks around the world. Going back to 2000, you can clearly see the magnitude is unlike any other. And don’t forget the Fed and other central banks are also unwinding prior stimulus by shrinking their massive balance sheets.
As a result, liquidity is being quickly removed from the financial markets, while fixed-income securities are becoming more attractive because of higher yields. That combination is the driver behind falling stock prices.
Despite the volatile reaction from stocks, last week’s inflation figures reinforce the quick pace of tightening by the Fed and other central banks around the world. Staying true to the Fed’s mandate is something I discussed in last week’s update.
Regardless, any time a powerful rally does unfold and the bottom-callers come out in full force (like on Thursday), the first metrics I examine are breadth. And I can tell you that the participation in Thursday’s stock market “about face” was lacking any real punch.
The ratio of advancing stocks to declining stocks on the New York Stock Exchange reached just 5 to 1, which is well below the levels seen around prior bear market bottoms.
That means I’m still watching and waiting patiently on the sidelines while sitting mostly in cash. If anything, the most intriguing chart setups I see are on the short side…particularly in high-growth stocks that have already been decimated by this bear market.
Like the type of stocks held by the Ark Innovation ETF (ARKK). Just take a look at five-year weekly chart of ARKK below, where price took out a key support level that stretches back to 2018. All the post-pandemic gains have vanished, and the weekly MACD reset at the zero line means that momentum is charged for another move lower.
This is exactly what the 2000 dot-com bust was like. Just when you thought highly speculative growth stocks couldn’t go any lower, the next wave of selling commences. I believe we are at a similar point in this bear market, and could see the next leg lower.
There are several short setups on my watchlist. I covered a few ideas in last week’s Mosaic Chart Alerts. I’ve also been highlighting the setup in LCID over the past week, which I updated on Friday:
And similar to ARKK, many other stocks in the growth space are starting to break key support levels, like with SE. You can see price created a support level around $53 going back to May, which gave way on Friday.
My list of long setups is shrinking, but there are still a few out there. DINO continues to show good relative strength, and is still holding its breakout.
I’m also following LW, which continues to trade near its 52-week high. A move over the $85 level on higher volume would be a great breakout signal in the chart below.
That’s all I have for this week. I know it’s tough to stay focused when the stock market packs a year’s worth of movement into a single day! But don’t lose sight of the big picture. Staying disciplined and patient is the key to surviving bear markets!
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Disclaimer: these are not recommendations and just my thoughts and opinions…do your own due diligence! I may hold a position in the securities mentioned in this newsletter.