The Market Mosaic 2.5.23
The Fed, payrolls, earnings…here's a better way to track the economy.
Welcome back to The Market Mosaic, where I gauge the stock market’s next move by looking at macro, technicals, and market internals. I’ll also highlight trade ideas using this analysis.
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And 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…
The Federal Reserve’s interest rate decision, January payrolls, earnings releases, reports on current business activity….
Last week was packed full of important economic releases and financial updates from some of the largest corporations on the planet. And sure enough, the data delivered plenty of fireworks.
The Fed came through with a 0.25% rate hike as expected, but chairman Jerome Powell caught most investors off guard when he shrugged off easing financial conditions. Signs of less stress in the capital markets can offset the Fed’s efforts to slow economic activity, and you can see below that conditions are easier than when the Fed first raised rates.
But if you needed any indication there’s more work for the Fed to do, Friday’s payrolls report showed 577,000 new jobs were created in January. That was more than double economist estimates, while the unemployment rate fell to 3.4%...the lowest level since 1969 (see the chart below from Reuters).
Stocks whipsawed in response, jumping on Powell’s comments and then dropping after payroll data points to a longer rate hiking cycle.
As a trader, trying to keep up with the market’s mood swings in response to the news is no easy task. But there’s no need to stress over the ups and downs. Developments under the stock market’s hood can foreshadow what lies ahead for the economy.
Here’s the data points that matter most.
The Message From the Leaders
I learned long ago that it’s pointless to anticipate and trade on the news. Whether it’s the latest important economic release or an earnings report…I have no way of predicting what will happen or how stocks will respond.
Most releases, like the jobs report, deal with the past anyways. I’m more concerned about what lies ahead.
And since the stock market is a discounting mechanism for future business conditions, I turn to sector performance to take the temperature of the economy and stock market.
Last year, it was consumer staples leading the way. The chart below shows a ratio of the S&P 500 against the XLP consumer staples ETF along with the 200-day moving average (green line). A falling line means that staples are outperforming, where defensive leadership has characterized the bear market.
But look at what’s happened since the start of 2023. Staples have turned into laggards and a new type of sector has taken the reins…and that is with cyclical stocks.
The fortunes of cyclical companies are tied directly to the state of the economy, so their stock prices reflect the outlook for business conditions. I focus on ETFs across three main groups to track their price trends:
IYT: Transportation companies that move goods by land, air, and railroad.
SMH: Semiconductor manufacturers since electronic content is making its way into just about everything.
IWM: Small-cap firms which generally receive more of their sales in the U.S. relative to large-caps.
In 2023, all three groups are off to a hot start as you can see in the chart below. Semiconductor stocks alone are up nearly 23% to start the year, and I previously showed you how strength in this sector was hinting at the S&P breakout over its 200-day MA.
Transportation stocks and small-caps are also taking out important chart levels with their recent move higher. Amid last week’s flurry of economic data, transport stocks were breaking out of an ascending triangle pattern. Small-caps broke out from a recent trading range as well.
The trends across semiconductors, transports, and small-caps are a positive sign for the economy and risk-on signal for the stock market.
That action is also being confirmed by developing breakouts across watchlist names covered in Mosaic Chart Alerts.
I place a big emphasis on breadth to measure participation in the stock market’s trend. An expanding number of stocks supporting a move is a great sign the trend can continue. Conversely, deteriorating breadth can warn of a trend in jeopardy.
I also closely follow the action of my watchlist setups, many of which I share in Mosaic Chart Alerts. And something happened last week that I haven’t seen in a long time…every buy setup from last week’s watchlist is breaking out!
That’s an important character change in the market, and stands in stark contrast to last year when breakouts were hard to come by. And those that did breakout often flamed out. The recent action in our setups is confirming the message coming from cyclical sectors discussed above.
I may still be cautious on the economic outlook and earnings picture for 2023, but I trade with the trend above all else. And no matter how loud the bears are screaming, you can’t deny the recent strength and leadership from the right groups. That confirms bullish hints from the start of the year that I covered here.
I will note that sentiment is getting too bullish following this rally (see the chart below of CNN’s Fear & Greed Index), and a near-term pullback could be constructive. But I won’t become overly concerned about significant downside until we see negative breadth divergences like those I highlighted heading into December’s decline.
Several of our breakout setups are getting too extended from proper buy points for new purchases. But there are still fresh setups developing. That includes ULH in the transportation space, where the stock is starting to breakout from a triangle continuation pattern.
If we do take a break from this rally and see a pullback, I’m eyeing short setups in the solar space. That includes RUN, where I’m watching for a move below trendline support at the $16 level as you can see in the chart below.
That’s all for this week. It’s easy to get caught up in the bullishness of the stock market and lose focus when things are working. But this is the time to stay disciplined by buying proper chart setups and respecting risk if trades don’t work out. Trends can change in a hurry, so stay flexible and objective in your approach and analysis!
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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.