The Market Mosaic 7.3.22
Seasonally bullish, structurally bearish
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 I’m tracking using this information.
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First, I want to wish you a happy Fourth of July! Please stay safe as we celebrate America’s independence day!
Now for this week’s issue…
That was brutal.
Maybe you’ve heard by now, but the S&P 500’s 20.6% decline in the first half of 2022 ranks as the fourth worst in history. The chart below from Stocktwits/Finviz shows returns for that period across a variety of assets and commodities.
To summarize, energy and agricultural commodities good, just about everything else bad. No need to spend more time recapping the first half of the year. After all, I’m way more concerned about what lies ahead versus what’s already happened.
So today I want to address two big developments I’m watching as we start the second half.
Two for 2H22
Today, I want to highlight two critical catalysts to watch as we enter the second half. The first is with treasury yields, and specifically the action seen in the 10-year. Since the start of the year, rising interest rates across the curve have pressured stock valuations (I explained the relationship between rates and valuations here).
So you may think it’s good news for stocks that the relentless march higher in the 10-year Treasury came to an abrupt halt this past week and turned lower. In doing so, the 10-year is taking out the 50-day moving average (black line) for the first time since the start of the year.
Falling yields may seem like a good thing for stock valuations, but I think this is a warning about future growth. Just like the recent sharp pullback in many commodity prices, a falling 10-year yield is signaling investor fears over a growth slowdown and consumer demand destruction from monetary policy.
And that directly ties into the next concern…
So far this year, falling valuations (like the P/E ratio) have accounted for all of the stock market’s decline. On the eve of the second quarter earnings season, I think that downward earnings revisions is the next shoe to drop.
Earnings estimates have held up remarkably well, but that’s because sell-side analysts tend to follow along with company guidance. With recent earnings reports and warnings from the likes of Micron (MU) and General Motors (GM), the 2Q reporting season could finally see a big guidance markdown and subsequent cut to analyst estimates.
That means the same factors causing a plunge in consumer sentiment are coming for corporate profit margins next…check out the divergence in the chart below posted by Callum Thomas:
Now What…
Big picture, structural market forces (i.e. falling liquidity) still have us in a bear market. In addition to the concerns listed above, I’ve recently pointed out the lack of capitulation signals that tend to mark the end of a bear. And last week saw several bearish setups play out well. That included a textbook breakdown and test of resistance with Deutsche Bank (DB) recapped here:
And this pennant breakdown in Trade Desk (TTD):
But powerful rallies can happen in bear markets. In fact, my short-term directional bias is leaning bullish. Part of the reason is that VIX is setting up to breakdown from the pattern we’ve tracked for weeks now (good for stocks). Another reason is that stocks are entering the best 2-week period for returns based on the historical calendar.
On the long side, I’m currently holding a position in RGP, VIVO, and FNKO that I covered last week. But there are several other setups on the radar as well.
KNSL
This weekly chart is shaping up nicely with a massive base stretching back to the start of 2021. I’m waiting for a breakout move over the $240 level at trendline resistance to start a long position.
JKS
Both China and solar names have been showing good relative strength lately and JKS is no exception. I started a small position last week, and will look to add more on a move over $70.
IMXI
This stock had a very important breakout over $18 back in March, then went through a basing process which tested that breakout level. I started a small position last week, and will add on a move over $22.
All in, cash is still by far my largest position because I still don’t have any firm evidence that this bear market is over. But I believe in being tactical and listening to the price action of individual stocks. That price action delivered several solid bearish setups last week, but there are many signs that selective long positions can work in his market.
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.