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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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…
Stocks took a sudden turn for the worse on Friday, with the S&P 500 Index dropping 1.3%. The decline had all the hallmarks of a “risk-off” move, with small-caps leading the way lower. For the ultimate tell in risk sentiment I track crypto assets like Bitcoin, where Friday’s 9% drop has price breaking down from another bear flag pattern as you can see below.
Should we be surprised by this pullback though?
In the previous issue of The Market Mosaic, I laid out my simple framework for tracking phases in asset prices. Those phases include a trending period, mean reversion, and consolidation.
My own trades are driven by the transition from a period of consolidation to a trending phase, while protecting profits and avoiding trades that show the potential for mean reversion. The chart below of DINO shows a recent example of each phase in action.
Seems simple enough, right? If it were that easy, then everyone would have no problem making money! The hard part is figuring out which phase is dominant, and when a new phase could begin (not to mention taming your emotions).
Friday’s action in stocks and other risk assets may reveal a critical junction for the next phase, which I believe also has major implications for a rotation in leadership. So this week, I want to revisit several metrics and evaluate the possible paths for the stock market, and where the opportunities exist now.
Transitioning the Price Phase
Lets start with a daily chart of the S&P 500. Following a relentless march higher since mid-June, the index finally tested the 200-day moving average. At the same time, momentum has become very extended as the MACD (see last week’s issue on how I use this indicator) has reached its highest level in over a year.
Measures of breadth have also become extended to the upside, like with the percentage of stocks trading above their 20-day moving average. It peaked at just over 80% and is now rolling over as you can see in the chart below.
Since daily momentum suggests a mean reverting phase, I’m looking for two things. First, I’m tracking the percent of stocks above their 20-day moving average for a move to an oversold condition, which for me is a reading of 30% or lower. I will also be watching the S&P 500’s proximity to support levels, including price and moving averages in the first S&P chart above. The key level I’m watching includes price support at 4,200, then the 50-day moving average (black line) which is also near price support at 4,000. I would also like to see the MACD reset at the zero line and recharge for another move.
For the mid-June rally off the lows to remain intact, I want to see the stock market work off extended momentum with a partial retracement of the gains while ultimately not making a new low. But beware, because if we are still in a bear market then the test of the 200-day moving average could set up another big decline as it did during the dot-com bear that I highlighted here. I’m being patient at these levels and waiting for clues as overbought conditions are worked off.
One other thing that I would highlight is that investor sentiment is no longer a bullish factor for equity prices. Following extreme levels of bearishness and fear, sentiment is about as neutral as you can get. There’s lots of ways to track sentiment, and CNN’s Fear and Greed Index combines several metrics into one indicator. You can see in the chart below how sentiment has quickly moved from extreme fear to neutral territory.
Now What…
Last week, I noted that we could see a return to the price trends that prevailed during the first half of 2022. That includes a stock market selloff coupled with rallying commodities and other value-linked sectors. At the very least, I expect the mean reversion phase to lead to more downside in the stock market, and how the S&P 500 reacts at key support levels will reveal the next major move. I’ll keep updating my thoughts here and on Twitter.
I’m not actively positioning on the short side just yet, mainly due to a lack of breakdown setups at this point. But I am paying close attention to the commodity space, where many stocks are showing signs of moving from a consolidation period and to a new trending phase. I noted last week how the setup in the oil and gas exploration and production ETF (XOP) showed signs of emerging from a consolidation. I still believe that’s the case with last week’s strong price action, which is why I highlighted several energy-related stocks in the most recent Mosaic Chart Alerts.
There are several other ideas to highlight this week, like with STR. This company acquires and owns mineral rights to oil and gas properties, and is another way to play rising energy prices. I’m watching for a breakout from this symmetrical triangle, with follow through over $30.
SBOW is another oil and natural gas producer that is on the verge of breaking out from an ascending triangle pattern. I’m watching the $48 level, with follow through above $50.
But it’s not all about energy stocks. On Friday, I posted this on Twitter about SUPN:
While SUPN’s earnings profile is one drawback, it’s hard to ignore the relative strength in this stock on a day when the rest of the market was plunging.
That’s all for this week. I’m still holding onto several long positions that have broken out as highlighted here and in Mosaic Chart Alerts, and I’m watching many opportunities developing in the commodity space. I won’t initiate any new positions until the breakout levels I highlight are cleared, while sticking with my risk management plan to cut losses or take profits on any position.
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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For updated charts, market analysis, and other trade ideas, give me a follow on twitter: @mosaicassetco
And if you have any questions or feedback, feel free to shoot me an email at mosaicassetco@gmail.com
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.