The Market Mosaic 3.12.23
Stocks are oversold, but that won't matter in a banking crisis.
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 levels that could trigger a trade.
Now for this week’s issue…
If Silicon Valley Bank (SVB) wasn’t a household name heading into this week, it is now. With $209 billion in assets, SVB became the largest bankruptcy since the financial crisis in 2008 and is the second largest in U.S. history.
The Federal Reserve’s tightening cycle hit the bank in several ways. A slowing economy caused money to leave the bank since customers needed their cash deposits, which turned into a bank run as you can see in the chart below from the Wall Street Journal. At the same time, rising interest rates also reduced the value of SVB’s bond holdings, and led the bank to realize $1.8 billion in losses after selling bonds to raise cash.
That same week featured Federal Reserve Chair Jerome Powell striking a hawkish tone in testimony to Congress. Powell specifically pointed to strong economic data as reasons why the Fed could be forced to raise rates at a quicker pace and hold them higher for longer.
Expectations for the next rate hike jumped all over the place. At one point, market implied odds pegged an 80% chance of a 0.50% increase following Powell’s remarks. That would be an acceleration from the last hike of 0.25%. But by the time the SVB fiasco came to a conclusion, odds for a larger hike were quickly falling:
Concerns that the Fed has pushed rates too far and is risking a calamity in the banking sector were on full display. Bank stocks got pummeled (chart of the KRE regional bank ETF below) while a flight to safety sent gold and Treasury bonds soaring.
Now with concerns that more SVB’s could be lurking, investors are on edge that the biggest threat to the banking system since the financial crisis is brewing.
While you should be prepared for more volatility-inducing headlines to start the week, lets stay objective by looking beyond the news and evaluating the good and bad developments taking place under the stock market’s hood.
Stocks are Oversold, but Key Sectors Breaking Down
Following a strong start to 2023, the stock market has been stuck in a downtrend since the beginning of February that has dragged the S&P 500 nearly 8% lower. But if there’s any good news in last week’s ongoing decline, it’s that extremely oversold conditions are emerging.
I noted last week how the percent of stocks trading above their 20-day moving average was nearing oversold territory. That’s a way to track how many stocks are trading in short-term uptrends, which is now buried at 12%. That’s the lowest level since stocks bottomed in late September as you can see in the chart below.
Other breadth measures are confirming oversold conditions as well. That includes the the McClellan Oscillator (chart below), which nets the difference between advancing and declining stocks on the NYSE over a trailing period. That metric just hit one of the lowest readings since the bear market began, indicating that breadth is approaching “washed out” levels.
The pullback is also ramping bearish sentiment, which is now firmly into “fear” territory. You can see that with CNN’s Fear and Greed Index below. This metric is comprised of seven different market based indicators to determine the mood of investors. That echoes surveys of individual investors to measure sentiment, where bulls have fallen to historically low levels. Sentiment works as a contrarian signal, where it pays to go against the crowd.
Extremes among both bearish sentiment and oversold conditions are historically great ingredients for a rally to unfold. But I would feel much better about potential upside if the trend backdrop was more constructive.
That’s because this move lower in stocks is taking a toll on key sectors of the market. I’ve noted in recent weeks that I’m monitoring the performance of cyclical sectors that are sensitive to developments in the economic outlook.
Those sectors will confirm the stock market’s next move, and last week featured breakdowns in several key ETFs. I showed you the action in regional banks above. That was echoed by small-cap stocks, where the IWM small-cap ETF is losing key price and moving average support as you can see in the chart below.
Here’s what I think of the conflicting signals from breadth, sentiment, and key sectors, and how I’m positioning heading into a pivotal week for the stock market.
This is a precarious spot for the stock market.
Bullish charts previously holding up are now breaking down, and the S&P 500 (chart below) is at a level that threatens the uptrend of higher highs and higher lows since October. Not only that, but the 200-day moving average (green line) and trendline support are giving way.
In an ideal scenario, the S&P 500 goes through a basing period around these levels while breadth improves under the hood. That’s the type of positive divergence we saw back in late September and early October. If that unfolds, this process could take time and will be filled with volatile, choppy price action. In a more adverse scenario, investor concerns over a credit crisis takes the S&P 500 back to the lows.
In either scenario, that means cash is king while waiting patiently on the sidelines. I noted in Mosaic Chart Alerts one of the advantages to being a breakout trader, which is naturally staying heavy in cash when breakouts are hard to come by. The past month has been one of those times.
Meanwhile, it’s our short setups playing out over the past week. That includes RUN from the short watchlist, which broke down hard from the pattern we’ve been tracking (chart below). Other breakdowns from the list include MKC and TSN.
If we do see a rally unfold from oversold levels, I’ll be watching setups in the semiconductor space. Chip stocks are holding up well, and I’ve discussed the setup in GFS frequently. I would also highlight MCHP, where the stock is basing just below all-time highs around the $88 trigger level in the chart below.
That’s all for this week. While oversold conditions and bearish sentiment are emerging positives for stocks, that won’t matter if concerns over the health of the banking system amplify. We also have another look at inflation this week with consumer and producer price reports, which is happening just ahead of another Fed meeting. That’s why I will be patiently waiting on the sidelines for improving conditions and evidence of a better trading environment.
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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.