SPY Analysis (November)
Updated
This is an analysis of the S&P 500 ETF ( SPY ) for November 2022.
Overview
The S&P 500 remains in a downtrend. While price bounced off of the 200-week moving average, there is a significant amount of overhead resistance. There has not yet been full backwardation in the VIX term structure that could lend credibility to the idea that a cycle low has been achieved. Cycle lows typically do not occur until after interest rates begin to decline. Therefore, so long as the Federal Reserve continues to raise interest rates, which reduces the supply of money, it is unlikely that the stock market can create new all-time highs.
The yield curve has inverted to an extreme degree. A yield curve inversion reflects a contraction in the credit market. Since credit is the main driver of the money supply and economic activity, an inverted yield curve is a warning sign of future economic decline. As the unemployment rate rises and corporate earnings decline, the stock market is likely to face a prolonged period of headwinds. Due to persistent supply issues in a deglobalizing world, commodity inflation is likely to persist even as demand cools, thus creating a difficult situation whereby, for the first time in a half-century, central banks' ability to increase the money supply to stimulate the economy is substantially limited.
The global economy is likely entering into a new supercycle where interest rates remain elevated or increase over the long term. This stagflationary environment is likely to stunt the S&P 500's growth prospects for the long term. Companies with negative cash flow and no pathway to profitability are likely to be severely affected. In the worst-case scenario, commodity hyperinflation, debt crises, and a monetary crisis are all possible in the years ahead.
Nonetheless, despite deteriorating macroeconomic conditions, plenty of great investment opportunities abound. Bullish post-election seasonality may carry the entire U.S. stock market higher, especially as market participants perceive a pivot in monetary policy. Overnight repo action hint that the Federal Reserve may have already stopped draining liquidity out of the banking system. As the world transitions to sustainable energy, companies that invest in sustainable infrastructure are likely to move substantially higher. Emerging markets, especially India and Latin America, are likely to be beneficiaries of flaring tensions between superpowers. It is during market turmoil that well-planned, risk-managed investments can prove most lucrative in the long term. Market bottoms form when all market participants become bearish and no sellers are left.
Quarterly Expected Move
There is a 68% chance that SPX will close the year within this price range.
High price: 4047
Low price: 3125
For those who do not already know, the quarterly expected move is the predicted range within which price is expected to remain at the close of the current quarter (3-month period). It is calculated using the implied volatility from the asset's options chain after the close of the prior quarter but before the market opens for the current quarter. For more information on how to calculate these values, please see the link at the bottom of this post.
Volatility & Seasonality
As noted above, there has not yet been complete VIX term structure backwardation. VIX term structure backwardation reflects that the market is pricing in decreasing volatility in the future. The VIX term structure usually goes into complete backwardation at cycle bottoms, as this structure reflects the type of capitulation that major stock market bottoms typically exhibit.
The VIX term structure currently shows that the market believes that higher volatility is to come (in 2023).
Fibonacci Levels
On the daily chart, price bounced at the 50% retracement level (Fibonacci levels drawn from the bottom in October to the most recent high on November 1st). If price can hold the 50% retracement level this shows relative bullishness.
Price also continues to cluster around the 3rd Fibonacci spiral that I discussed in my prior posts (see links to related ideas below).
Regression Channel
Regression simply refers to the idea that price tends to revert back (or regress) to its mean for a given timeframe. Regression channels can help us identify which trend is governing price action. These channels can give insight into trend reversals.
Since the start of 2022, the daily regression channel has been downsloping.
Price has recently bounced off the mean, despite downward oscillator momentum. This reflects bullishness.
Weekly Chart
In the below weekly chart, we can see the EMA ribbon has completely inverted. The EMA ribbon is a collection of exponential moving averages that act as resistance when price reaches it from below and support when price reaches it from above.
The last time the EMA ribbon completely inverted was during the Great Recession.
In general, the farther the S&P 500 falls, the wider the EMA ribbon will get. The wider the EMA ribbon gets, the harder it will be for price to pierce the ribbon and break out to the upside. The significance of this is that a wide and inverted EMA ribbon on the weekly chart makes a sharp V-shaped recovery less likely. This is because when the EMA ribbon is wide, each moving average will individually pose a challenge to price action more so than if all the moving averages are converged at nearly the same level.
Although the current situation differs in many ways from the Great Recession. Look below at how similar the weekly charts appear.
Another chart that has me concerned about a potential capitulation event is the weekly chart for the tech short derivative chart (SQQQ). As many of you know, when the price of tech stocks in the Nasdaq 100 ETF (QQQ) moves down, SQQQ moves up. SQQQ is an important chart to consider because it reflects the extent to which retail traders are bearish on tech stocks.
Right now, SQQQ's chart is particularly precarious and primed for a capitulation event because price fell to then bounced off of converged moving averages.
If we zoom out to view the entire price history of SQQQ we can see that its price rarely rises above the weekly EMA ribbon except during capitulation events, thus indicating that we are dealing with unprecedented bearishness of interest-rate-sensitive tech stocks.
For the tech bulls to prevail, SQQQ's price must fall below the EMA ribbon. Whereas if a capitulation event occurs, the Nasdaq 100 stocks can experience a rapid and significant decline back down to their pre-pandemic highs, as shown below.
This could mean that as a ratio to the money supply, the Nasdaq 100 goes all the way back to the March 2020 bottom, thereby wiping out all the wealth that investing in tech stocks created since the pandemic began.
To see why the money supply can be used in this manner, you can check out my post here:
Stage of the Economic Cycle
Since the 10Y/2Y yield curve remains inverted we are in the late stage of an economic cycle.
Below is a chart of how each sector typically performs during this stage.
Credit: Fidelity Investments
We are most likely in Stage 6 of the economic cycle as shown below because stock, bonds, and commodities have all been declining to some degree in the past several months and because the yield curve is inverted. Once the yield curve inverts, economic contraction will subsequently occur. Although the general trend of all assets is down during Stage 6 there can still be rallies before contraction takes hold.
Credit: StockCharts.com
Yearly Chart
When analyzed on the yearly chart, the S&P 500's current price action looks analogous to the Early 2000s Recession, as shown below.
Following the Early 2000s recession, it took over 12 years for the stock market to sustain new all-time highs. Although anything is possible, unfortunately the current situation is looking similar.
Bonds
This chart is a ratio of the S&P 500 (SPX) relative to the price of iShares 20 Plus Year Treasury Bond ETF (TLT). The regression channel gives us a very interesting piece of insight. It could suggest that the S&P 500 is nowhere near its bottom yet.
Since TLT's price drops when bond yields go up, this ratio chart suggests that for the current yield on risk-free long-dated government bonds, the S&P 500 could be way overpriced still. The higher the yields on government bonds rise, the more likely it is that capital will flow out of the stock market and into bonds. As shown below, the higher timeframe oscillators suggest this may be the case.
Yield Curve Inversion
The current yield curve inversion (as measured as a ratio between the 10-year vs. 2-year U.S. Treasuries) is the most extreme on record. This inversion is flashing a major recession warning.
Emerging Markets
Here's one investment idea that always works...
Please leave a comment if you find an error in my analysis above or if you'd otherwise like to share your thoughts. Thank you.
If you'd like to plot the weekly and daily expected moves for SPY on your chart, try the indicator "SPY Expected Move by VIX", which is calculated from the VIX rather than from the implied volatility of the options chain. The quarterly expected moves that I've posted above were calculated using options chain data. If you'd like to learn how to calculate the expected move yourself, this video can help: youtube.com/watch?v=Lhv3wiPv6Ok
Overview
The S&P 500 remains in a downtrend. While price bounced off of the 200-week moving average, there is a significant amount of overhead resistance. There has not yet been full backwardation in the VIX term structure that could lend credibility to the idea that a cycle low has been achieved. Cycle lows typically do not occur until after interest rates begin to decline. Therefore, so long as the Federal Reserve continues to raise interest rates, which reduces the supply of money, it is unlikely that the stock market can create new all-time highs.
The yield curve has inverted to an extreme degree. A yield curve inversion reflects a contraction in the credit market. Since credit is the main driver of the money supply and economic activity, an inverted yield curve is a warning sign of future economic decline. As the unemployment rate rises and corporate earnings decline, the stock market is likely to face a prolonged period of headwinds. Due to persistent supply issues in a deglobalizing world, commodity inflation is likely to persist even as demand cools, thus creating a difficult situation whereby, for the first time in a half-century, central banks' ability to increase the money supply to stimulate the economy is substantially limited.
The global economy is likely entering into a new supercycle where interest rates remain elevated or increase over the long term. This stagflationary environment is likely to stunt the S&P 500's growth prospects for the long term. Companies with negative cash flow and no pathway to profitability are likely to be severely affected. In the worst-case scenario, commodity hyperinflation, debt crises, and a monetary crisis are all possible in the years ahead.
Nonetheless, despite deteriorating macroeconomic conditions, plenty of great investment opportunities abound. Bullish post-election seasonality may carry the entire U.S. stock market higher, especially as market participants perceive a pivot in monetary policy. Overnight repo action hint that the Federal Reserve may have already stopped draining liquidity out of the banking system. As the world transitions to sustainable energy, companies that invest in sustainable infrastructure are likely to move substantially higher. Emerging markets, especially India and Latin America, are likely to be beneficiaries of flaring tensions between superpowers. It is during market turmoil that well-planned, risk-managed investments can prove most lucrative in the long term. Market bottoms form when all market participants become bearish and no sellers are left.
Quarterly Expected Move
There is a 68% chance that SPX will close the year within this price range.
High price: 4047
Low price: 3125
For those who do not already know, the quarterly expected move is the predicted range within which price is expected to remain at the close of the current quarter (3-month period). It is calculated using the implied volatility from the asset's options chain after the close of the prior quarter but before the market opens for the current quarter. For more information on how to calculate these values, please see the link at the bottom of this post.
Volatility & Seasonality
As noted above, there has not yet been complete VIX term structure backwardation. VIX term structure backwardation reflects that the market is pricing in decreasing volatility in the future. The VIX term structure usually goes into complete backwardation at cycle bottoms, as this structure reflects the type of capitulation that major stock market bottoms typically exhibit.
The VIX term structure currently shows that the market believes that higher volatility is to come (in 2023).
Fibonacci Levels
On the daily chart, price bounced at the 50% retracement level (Fibonacci levels drawn from the bottom in October to the most recent high on November 1st). If price can hold the 50% retracement level this shows relative bullishness.
Price also continues to cluster around the 3rd Fibonacci spiral that I discussed in my prior posts (see links to related ideas below).
Regression Channel
Regression simply refers to the idea that price tends to revert back (or regress) to its mean for a given timeframe. Regression channels can help us identify which trend is governing price action. These channels can give insight into trend reversals.
Since the start of 2022, the daily regression channel has been downsloping.
Price has recently bounced off the mean, despite downward oscillator momentum. This reflects bullishness.
Weekly Chart
In the below weekly chart, we can see the EMA ribbon has completely inverted. The EMA ribbon is a collection of exponential moving averages that act as resistance when price reaches it from below and support when price reaches it from above.
The last time the EMA ribbon completely inverted was during the Great Recession.
In general, the farther the S&P 500 falls, the wider the EMA ribbon will get. The wider the EMA ribbon gets, the harder it will be for price to pierce the ribbon and break out to the upside. The significance of this is that a wide and inverted EMA ribbon on the weekly chart makes a sharp V-shaped recovery less likely. This is because when the EMA ribbon is wide, each moving average will individually pose a challenge to price action more so than if all the moving averages are converged at nearly the same level.
Although the current situation differs in many ways from the Great Recession. Look below at how similar the weekly charts appear.
Another chart that has me concerned about a potential capitulation event is the weekly chart for the tech short derivative chart (SQQQ). As many of you know, when the price of tech stocks in the Nasdaq 100 ETF (QQQ) moves down, SQQQ moves up. SQQQ is an important chart to consider because it reflects the extent to which retail traders are bearish on tech stocks.
Right now, SQQQ's chart is particularly precarious and primed for a capitulation event because price fell to then bounced off of converged moving averages.
If we zoom out to view the entire price history of SQQQ we can see that its price rarely rises above the weekly EMA ribbon except during capitulation events, thus indicating that we are dealing with unprecedented bearishness of interest-rate-sensitive tech stocks.
For the tech bulls to prevail, SQQQ's price must fall below the EMA ribbon. Whereas if a capitulation event occurs, the Nasdaq 100 stocks can experience a rapid and significant decline back down to their pre-pandemic highs, as shown below.
This could mean that as a ratio to the money supply, the Nasdaq 100 goes all the way back to the March 2020 bottom, thereby wiping out all the wealth that investing in tech stocks created since the pandemic began.
To see why the money supply can be used in this manner, you can check out my post here:
Stage of the Economic Cycle
Since the 10Y/2Y yield curve remains inverted we are in the late stage of an economic cycle.
Below is a chart of how each sector typically performs during this stage.
Credit: Fidelity Investments
We are most likely in Stage 6 of the economic cycle as shown below because stock, bonds, and commodities have all been declining to some degree in the past several months and because the yield curve is inverted. Once the yield curve inverts, economic contraction will subsequently occur. Although the general trend of all assets is down during Stage 6 there can still be rallies before contraction takes hold.
Credit: StockCharts.com
Yearly Chart
When analyzed on the yearly chart, the S&P 500's current price action looks analogous to the Early 2000s Recession, as shown below.
Following the Early 2000s recession, it took over 12 years for the stock market to sustain new all-time highs. Although anything is possible, unfortunately the current situation is looking similar.
Bonds
This chart is a ratio of the S&P 500 (SPX) relative to the price of iShares 20 Plus Year Treasury Bond ETF (TLT). The regression channel gives us a very interesting piece of insight. It could suggest that the S&P 500 is nowhere near its bottom yet.
Since TLT's price drops when bond yields go up, this ratio chart suggests that for the current yield on risk-free long-dated government bonds, the S&P 500 could be way overpriced still. The higher the yields on government bonds rise, the more likely it is that capital will flow out of the stock market and into bonds. As shown below, the higher timeframe oscillators suggest this may be the case.
Yield Curve Inversion
The current yield curve inversion (as measured as a ratio between the 10-year vs. 2-year U.S. Treasuries) is the most extreme on record. This inversion is flashing a major recession warning.
Emerging Markets
Here's one investment idea that always works...
Please leave a comment if you find an error in my analysis above or if you'd otherwise like to share your thoughts. Thank you.
If you'd like to plot the weekly and daily expected moves for SPY on your chart, try the indicator "SPY Expected Move by VIX", which is calculated from the VIX rather than from the implied volatility of the options chain. The quarterly expected moves that I've posted above were calculated using options chain data. If you'd like to learn how to calculate the expected move yourself, this video can help: youtube.com/watch?v=Lhv3wiPv6Ok
Note
UpdateIn the intermediate term (heading into the close of 2022) it is quite possible that bullish factors may prevail over bearish factors. Post-election seasonality and market participants’ perception that the Fed will soon pause hikes are bullish factors that are likely to carry the stock market modestly higher into the close of the year. The yield curve has inverted and in past economic cycles, the stock market typically rises between the period after a yield curve inversion and before the start of the impending recession.
With that said, from a technical standpoint there is still a significant amount of overhead resistance. On the weekly chart, the SPX remains trapped under the exponential moving average (EMA) ribbon.
More importantly, a significant and prolonged recession is almost certainly coming and will begin in 2023. Therefore, there is very little time between when the Fed will pause on rate hikes and when a formal recession will begin. Indeed, it’s possible that the Fed will actually hike right into the start of the coming recession. This will provide little to no respite from market headwinds.
The Federal Reserve has engineered the worst yield curve inversion on record. As noted previously, a yield curve inversion is a central bank monetary policy phenomenon that is specifically designed to reduce the money supply and thus reduce economic activity. The primary reason for the Federal Reserve to invert the yield curve is to induce an economic recession. In this regard, those betting there won’t be a recession are betting against the Fed.
Days ago, the 30-year yield inverted relative to the 3-month yield. This is another warning sign that there will be a scarcity of dollars and thus liquidity issues in the future.
As we saw this week, FTX was the canary in the coal mine. Like a canary that dies from toxicants in the coal mine long before a human does, major liquidity issues always hit the most speculative fringes of the market first. It is no surprise that FTX collapsed, and it is likely that more will follow as the dollar scarcity gets worse.
U.S. companies are already rushing to cut costs as they are confronted by a worsening money scarcity. Tech companies which are growth dependent and at the forefront of liquidity issues are announcing hiring freezes and some are already announcing layoffs.
Aside from freezing hiring, companies will freeze pay increases, reduce hours and cut employee benefits, including employer retirement contributions. This last measure will begin to slow the flow of money into mutual funds and underlying constituent ETFs. This decrease of inflows will create a new headwind for the stock market as a whole. As unemployment goes up, ETF inflows will go down. These cost-cutting measures will likely accelerate rapidly in the first quarter of 2023.
As the liquidity issues worsen, layoffs will accelerate through positive feedback loops. Since commodity supplies are likely to remain persistently constrained even as demand cools, central banks will not be able to completely pivot back to monetary easing. They may be forced to try limited interventions whereby they extinguish individual fires rather than dump an ocean of money on the entire economy as in March 2020. This limited intervention strategy, however, will likely result in a prolonged (and possibly deep) recession. Speculative fringes of the market will suffer the most if they survive at all. There’s simply no way that central banks can drown their economies with money again and not risk hyperinflation. As geopolitical tensions mount, commodity supply issues could worsen even further. In a worst-case scenario, commodity hyperinflation and/or debt and liquidity crises will reverberate across all levels of the financial markets up to and including sovereign debt.
Nonetheless, these crises are not unprecedented. Regardless of the extent or duration of declines, consistent and steady contributions as part of a long-term investment strategy in low-fee, broadly diversified mutual funds (especially via tax-sheltered retirement accounts) are likely to do perfectly fine in the long run. When bond yields peak, they will likely provide a rare opportunity to invest in a low-risk asset class with a decent return for a significant discount.
Traders should be mindful that a rapidly shrinking money supply will mean that profits will be reduced and/or become rarer. Both longs and shorts are more likely to lose money as money itself becomes scarcer. This means that volatility of volatility or the VVIX will likely rise such that short squeezes and price collapses become more common and happen in rapid succession. Also remember that derivatives are most prone to liquidity issues. In the face of major liquidity issues, both long and short positions in derivatives can lose money. Take a look at the below chart of the money supply (M2). For the first time on record (going as far back as data are available – 1960), the supply of money has shrunk for two consecutive quarters.
Since March 2022, when the Fed pivoted to monetary tightening, the money supply has declined at the fastest rate on record.
If you’re extremely bullish in a particular asset, ask yourself the following question: Where is all the money going to come from to push the price of the asset to record highs? Unless the money supply increases, it’s likely that only assets with underlying scarcities (such as commodities) have the potential to pave new highs.
Finally, I never doubt the stock market’s ability to go up over the long term. Over the long term, the stock market has shown incredible resiliency. The stock market has weathered great wars, great crises, and great panics before. The result has always been that it has continued its upward trajectory in the long term. As we end a terrible year for the stock market, keep in mind that regardless of conditions in the short term, the stock market will remain the best means of wealth preservation in the long term.
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