The Market Mosaic 5.22.22
Friday stock snapback...more in store?
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.
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Now for this week’s issue…
Almost a bear market.
At one point during the trading day on Friday, another selloff brought the S&P 500 firmly below the 20% pullback threshold. Miraculously, the index managed a late day rally and avoided closing in that bear market territory.
I find this all amusing. Who came up with a 20% threshold to classify a decline as a bear market?
Here’s what I know about the matter. Last week marked the seventh straight weekly decline in a row for large-caps. That’s something not seen since the 2001 demolition of the stock market.
So down 20%, or down 18%...it is a bear market folks. And it has been since last year for the average stock. Now during those bear markets, you have to be opportunistic. Buy and hold has worked for most of the past decade…not anymore. Here’s the S&P chart since the start of the year:
That’s why my recent newsletter issues have voiced a similar conclusion: wait patiently on the sidelines in cash and evaluate the next potential move.
We’ve already played many bear flag breakdowns that I recapped last week, and are now waiting for new setups to develop. Will those setups be bullish, or more downside plays?
Here’s what I expect for the next move.
Is That Rally Still on the Way?
Last week, I outlined several reasons why I expect a bear market rally to unfold in stock market. Yes, the S&P 500 did extend its losing streak as I noted above.
But guess what?
Some of the biggest losers in this bear are showing relative strength. Even as the S&P 500 made intraday new lows last week, small-cap stocks held up as I highlighted here:
Even the poster child for this move lower, the Ark Innovation Fund (ARKK), didn’t break down to new lows. Maybe that’s because both ARKK and small-caps (IWM) are testing massive, multi-year support levels. Check out these 5-year weekly charts of both ARKK and IWM:
Lets get one thing straight first. Just because I draw a line on a chart doesn’t mean the decline will stop there. But these are crucial long-term support levels that must be monitored, and it’s logical to expect at least some type of reaction here.
At the same time, market internals are delivering hints that you should not give up on the prospect of a rally. I’m paying attention to two signs in particular. One is the ratio of NYSE advancing stocks to declining stocks, which has shot up to over seven (or put another way, 7 advancers for each decliner) on recent rally attempts. That’s a strong figure, and we saw two readings cluster just recently.
Another is the percentage of stocks across the market trading above their 20-day moving average. Take a look at this metric against the S&P 500. As the index dropped to a new low last week, fewer stocks are in short-term downtrends. A similar dynamic developed just before the March rally took the S&P 11% higher in just two weeks.
Finally, I continue to track signals coming from volatility. I’m watching developments in this new VIX pattern that I highlighted on Twitter last week. A move below 25 signals a rally, while a move over 33 means renewed selling in stocks. I explain the VIX relationship with stocks here.
Now What?
Generally speaking, many stocks are so oversold that I view most bearish bets as high risk. That means stocks in downtrends are quite extended after breaking down from bearish chart patterns, and are prone to snap back.
Given the green shoots signaling a rally, I’m favoring tactical long positions in stocks breaking out from basing patterns. We’re finally starting to see some action on this front. I started a couple small positions last week. One was in Kronos (KRO) on this weekly pennant breakout. The stock traded back near the prior high at $18. A breakout can target $22.
Shipping stocks are another group showing relative strength. I posted on Twitter about the move happening with Diana Shipping. If this stock can clear the $6 level, that could open the door to $8.
I started this issue of The Market Mosaic by stating that you need to be opportunistic. A tactical mindset backed by an objective strategy is critical to navigate this market, and right now signs point to opportunities on the long side. But this is not the time to be overly aggressive, and a heavy cash allocation is still the best core position.
That’s all for this week. I hope you’ve enjoyed this edition of The Market Mosaic, and please share this newsletter with anyone you feel could benefit from an objective look at the stock market.
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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.