In depth analysis of the stock market! Macro series pt3
Updated
Part 3 This is the third part of the macro analysis series. In this part we'll focus on analyzing the current situation of the stock market based on fundamental and technical analysis, while trying to map out the future depending on how the Fed and the economy move. You can find the rest of the analysis on the links down below.
Let’s now transition into stocks and have a look at the three major US indices, as they are the best way to get a good picture of what is going on in stocks markets broadly. It is hard to find a way to get the full picture in one chart, especially when it comes to looking things globally. That’s why we’ll focus only on the S&P 500, Nasdaq 100 and Russell 2000, due to the fact that the US has been leading this rally, as well as because we can get information on the performance of different types of stocks. Starting with the S&P, it is clear that it has broken its uptrend and has found support on the first major support level, around 4220-4280. On that level it also happens to be the 300 DMA, but the issue is that the market keeps testing the support (bearish) and it has been rejected by the 200 DMA on the first bounce. Nevertheless, the support has held beautifully up until now and might have even bottomed. In our opinion this isn’t the final bottom as we expected to see more downside at some point in 2022, with 3900-4000 being the first major target. This area is potentially one of the best ones for the final bottom as that’s the only breakout the market didn’t retest, plus there is a gap there on SPY. So far, the current correction was 12.4% top to bottom, and getting down to 3900-4000 would be around 18%, which is more than enough for a major bottom to be in. Back in 2018 it took a 21% correction for the Fed to pivot and stop raising rates. It wouldn’t surprise us at all if the Fed was forced to stop raising rates and maybe even restart QE if the S&P500 fell more than 20%, although it wouldn’t do it just because stocks fell. If US treasury bonds are going down (yields up), then the 60/40 portfolios would be losing value rapidly by being forced to sell both bonds and stocks. Of course, the problem isn’t just these two markets going down and affecting investor sentiment and spending, but the problems they can create on credit markets broadly. For example, if stocks and bonds go down, it is very likely that corporate bonds will go down too, and therefore many companies which are already struggling, would be forced to borrow with much higher yields or not be able to borrow at all. Again, the problem is that there is too much debt and the system isn’t be able to withstand rapid changes in interest rates and liquidity.
Like we mentioned above, the S&P doesn’t show the full picture, so we need to add the other two major indices to the mix. We’ll start with some important stats and move into their charts. From their Feb 2020 highs, the S&P went up 41%, the Nasdaq 71% and the Russell 44%. The Russell was the best performer from the March 2020 bottom up until March 2021, where it started going sideways and entered a very clear distribution phase. That’s because it benefited the most from long term US yields going up and the loose financial conditions that helped smaller companies do well. Another important component to the rally was the speculative mania that started from the Wall Street Bets subreddit with Gamestop, and then spread into other heavily shorted companies which started rallying hard. This is potentially a sign that deflation is coming back and that buying US large caps is still the best bet over the next few months. However, once that mania started reaching its peak, we saw several sectors and ETFs roll over, in and out of the US. We saw SPAK, ARKK and even the Shanghai index all top at the same time on Feb 2021. In exactly one year the RUT had 150% rally from top to bottom and until reaches its 2018-2019 highs it will probably underperform relative to other major US indices. Despite many stocks performing poorly, the SPX and NDX kept going higher, so it started becoming obvious that something was shifting. So how did that happen? How could several sectors of the market go down, how could so many stocks go sideways and lose value, and the major US indices continue to rally? The clear explanation is that the rally was led by US tech giants. US tech behemoths kept gaining market share and kept growing and growing. Despite what many people might think, these tech behemoths going up while everything else is suffering isn’t a long-term bullish signal, neither an inflationary one. That’s because many view these companies essentially as safe assets and treat them like long duration bonds.
When looking at where stocks are right now, it is very clear that they are significantly oversold on a Daily timeframe, something also confirmed by several metrics. At the same time though, they are still pretty expensive as they had exceeded the yearly average return (10%) by a lot. Their momentum is strong to the downside and on a weekly timeframe they haven’t gotten oversold. Many of you have probably heard people say many times that the stock market is overvalued and that a big bear market is near, only to see the market rally relentlessly up until a month ago. It is very important to note that the stock market based on most metrics is actually overvalued and has reached levels that historically would have led to a bear market. Even though this might be true; it doesn’t mean that because a certain signal worked in the past it will work again. Regardless of what all these metrics are indicating, the stock market could pull another 2-3x from here in the next decade, while having several 10-30% corrections in the meantime. That’s because the dynamics of the markets are very complex and keep evolving, while more and more people are depended on the stock market to go up, both of which have turned the stock market as something that the government and the Fed need to protect. Even if that wasn’t the case, any market can stay irrational for a very long period of time. All the people who are believe they are thinking rationally are dumfounded because invest based on some potentially outdated models, as they discount many other factors like market structure, psychology and liquidity. Eventually they will probably be right, but in the meantime, they’d have missed a lot of opportunities.
Currently the SPX and NDX flirted with support for a bit and bounced, while RUT made a new low and then bounced. The next resistance for SPX and NDX is 3-5% higher, while for RUT it is 5-10% higher. Getting there doesn’t mean we will get a huge rejection, as it is more likely that markets take a break and chop before deciding which direction they are going to choose. It is even possible that the SPX could make new ATHs before it starts rolling over again. The reason is that we could shake out late bears and potentially late longs coming in to take advantage of the ‘liquidity’ the Fed is providing as QE hasn’t stopped yet. The fact that the markets closed the week at pretty much the same level they were before hawkish Fed meeting, is fairly bullish. Because it means that the markets have somewhat priced in a lot of the negativity and there are many people who sold late. Even from a sentiment point of view, there are several ‘indicators’ that are screaming buy. Some examples are twitter polls both in stocks and crypto being skewed 25/75 bullish/bearish, real-life people I know that wanted to buy at 65k BTC tell me they are worried that I could lose everything, as well as everyone on twitter talking about how ARKK is down so much that its 2-year performance is now equivalent to that of Berkshire Hathaway.
In terms of the next key support for SPX and NDX, it is 10% lower while for RUT it is 10-16% lower. If the market gets there, we could either see the final bottom there, or simply a very and a strong bouncer. It is pretty early to tell whether the bull market is over yet, but in our opinion it seems unlikely. By looking back at the 1995-2000 period on the NDX, we can see that once the market broke above the major diagonal resistance, there were lots of 10-20% corrections and retests of that diagonal. This time around we’ve only tested the diagonal twice and this the largest correction out of the four that have occurred and were larger than 10%. The only index out of the three that is indicating major issues, is the Russell.
Another very important index that isn’t tracking the performance of stocks, but is tracking the volatility of the stock market is the VIX. The VIX can give us a lot of information around fear, uncertainty and change, based on the levels it is trading at and based on how it’s moving. Generally speaking, when the VIX is trading below 16, there is little uncertainty, fear and change, when the VIX is trading 16-32 things there is change, however fear and uncertainty are at moderate levels, while with VIX above 32 there is a lot of uncertainty, a lot of fear and things are changing rapidly. The higher the VIX, the more intense the sentiment on the market. During this correction the VIX got up to 39, which historically is pretty high and was even higher than the 36-37 zone which has as acted as ‘resistance’ on the VIX several times in the past. Although this could be the top for the VIX (bottom for stocks) like in Dec 2018 when the Fed was hiking rates, in our opinion it isn’t and we expect 48-50 to be the top for VIX (bottom for stocks). There are several reasons behind this thinking and a lot goes back to the Fed, the economy, etc, most importantly however, it has to do with the psychology of the market. We feel investors haven’t been scared enough in order to fully capitulate and be shaken out of their longs, neither is the Fed cornered enough to do a 180 turn yet. With so many things changing in the world it doesn’t make sense for volatility to be so low and that at some point as the Fed is raising rates, something could break and cause significant panic. One thing to keep in mind is that in case of severe economic weakness and rapid drop in the inflation rate, then the Fed could use that as an excuse not to raise rates before the market forces them to stop. In that scenario the VIX might topped for a very long time at 39, as the markets will assume the Fed has their back and they don’t have to worry about higher interest rates.
During the GFC the VIX peaked at 95 and during the Covid crash at 85. Back then once it got down to 15-16 it had two spikes up to 48, while this time around it has remained lower with most peaks below 40. Of course, 39 is a perfectly reasonable top for 2022, although we don’t see a way that the Fed hikes 3+ times without at least one of them creating significant panic. Last point on the VIX and stocks broadly, is that it looks like it has formed a significant bottom throughout 2021 and that it currently has a proper long term bullish structure. It’s pretty rare to see it form significant higher highs and higher lows, which could be seen as a sign that there is at least another leg up. Maybe go down to 18-22, test the yearly Pivot & the major moving averages, and then pump.
Let’s now transition into stocks and have a look at the three major US indices, as they are the best way to get a good picture of what is going on in stocks markets broadly. It is hard to find a way to get the full picture in one chart, especially when it comes to looking things globally. That’s why we’ll focus only on the S&P 500, Nasdaq 100 and Russell 2000, due to the fact that the US has been leading this rally, as well as because we can get information on the performance of different types of stocks. Starting with the S&P, it is clear that it has broken its uptrend and has found support on the first major support level, around 4220-4280. On that level it also happens to be the 300 DMA, but the issue is that the market keeps testing the support (bearish) and it has been rejected by the 200 DMA on the first bounce. Nevertheless, the support has held beautifully up until now and might have even bottomed. In our opinion this isn’t the final bottom as we expected to see more downside at some point in 2022, with 3900-4000 being the first major target. This area is potentially one of the best ones for the final bottom as that’s the only breakout the market didn’t retest, plus there is a gap there on SPY. So far, the current correction was 12.4% top to bottom, and getting down to 3900-4000 would be around 18%, which is more than enough for a major bottom to be in. Back in 2018 it took a 21% correction for the Fed to pivot and stop raising rates. It wouldn’t surprise us at all if the Fed was forced to stop raising rates and maybe even restart QE if the S&P500 fell more than 20%, although it wouldn’t do it just because stocks fell. If US treasury bonds are going down (yields up), then the 60/40 portfolios would be losing value rapidly by being forced to sell both bonds and stocks. Of course, the problem isn’t just these two markets going down and affecting investor sentiment and spending, but the problems they can create on credit markets broadly. For example, if stocks and bonds go down, it is very likely that corporate bonds will go down too, and therefore many companies which are already struggling, would be forced to borrow with much higher yields or not be able to borrow at all. Again, the problem is that there is too much debt and the system isn’t be able to withstand rapid changes in interest rates and liquidity.
Like we mentioned above, the S&P doesn’t show the full picture, so we need to add the other two major indices to the mix. We’ll start with some important stats and move into their charts. From their Feb 2020 highs, the S&P went up 41%, the Nasdaq 71% and the Russell 44%. The Russell was the best performer from the March 2020 bottom up until March 2021, where it started going sideways and entered a very clear distribution phase. That’s because it benefited the most from long term US yields going up and the loose financial conditions that helped smaller companies do well. Another important component to the rally was the speculative mania that started from the Wall Street Bets subreddit with Gamestop, and then spread into other heavily shorted companies which started rallying hard. This is potentially a sign that deflation is coming back and that buying US large caps is still the best bet over the next few months. However, once that mania started reaching its peak, we saw several sectors and ETFs roll over, in and out of the US. We saw SPAK, ARKK and even the Shanghai index all top at the same time on Feb 2021. In exactly one year the RUT had 150% rally from top to bottom and until reaches its 2018-2019 highs it will probably underperform relative to other major US indices. Despite many stocks performing poorly, the SPX and NDX kept going higher, so it started becoming obvious that something was shifting. So how did that happen? How could several sectors of the market go down, how could so many stocks go sideways and lose value, and the major US indices continue to rally? The clear explanation is that the rally was led by US tech giants. US tech behemoths kept gaining market share and kept growing and growing. Despite what many people might think, these tech behemoths going up while everything else is suffering isn’t a long-term bullish signal, neither an inflationary one. That’s because many view these companies essentially as safe assets and treat them like long duration bonds.
When looking at where stocks are right now, it is very clear that they are significantly oversold on a Daily timeframe, something also confirmed by several metrics. At the same time though, they are still pretty expensive as they had exceeded the yearly average return (10%) by a lot. Their momentum is strong to the downside and on a weekly timeframe they haven’t gotten oversold. Many of you have probably heard people say many times that the stock market is overvalued and that a big bear market is near, only to see the market rally relentlessly up until a month ago. It is very important to note that the stock market based on most metrics is actually overvalued and has reached levels that historically would have led to a bear market. Even though this might be true; it doesn’t mean that because a certain signal worked in the past it will work again. Regardless of what all these metrics are indicating, the stock market could pull another 2-3x from here in the next decade, while having several 10-30% corrections in the meantime. That’s because the dynamics of the markets are very complex and keep evolving, while more and more people are depended on the stock market to go up, both of which have turned the stock market as something that the government and the Fed need to protect. Even if that wasn’t the case, any market can stay irrational for a very long period of time. All the people who are believe they are thinking rationally are dumfounded because invest based on some potentially outdated models, as they discount many other factors like market structure, psychology and liquidity. Eventually they will probably be right, but in the meantime, they’d have missed a lot of opportunities.
Currently the SPX and NDX flirted with support for a bit and bounced, while RUT made a new low and then bounced. The next resistance for SPX and NDX is 3-5% higher, while for RUT it is 5-10% higher. Getting there doesn’t mean we will get a huge rejection, as it is more likely that markets take a break and chop before deciding which direction they are going to choose. It is even possible that the SPX could make new ATHs before it starts rolling over again. The reason is that we could shake out late bears and potentially late longs coming in to take advantage of the ‘liquidity’ the Fed is providing as QE hasn’t stopped yet. The fact that the markets closed the week at pretty much the same level they were before hawkish Fed meeting, is fairly bullish. Because it means that the markets have somewhat priced in a lot of the negativity and there are many people who sold late. Even from a sentiment point of view, there are several ‘indicators’ that are screaming buy. Some examples are twitter polls both in stocks and crypto being skewed 25/75 bullish/bearish, real-life people I know that wanted to buy at 65k BTC tell me they are worried that I could lose everything, as well as everyone on twitter talking about how ARKK is down so much that its 2-year performance is now equivalent to that of Berkshire Hathaway.
In terms of the next key support for SPX and NDX, it is 10% lower while for RUT it is 10-16% lower. If the market gets there, we could either see the final bottom there, or simply a very and a strong bouncer. It is pretty early to tell whether the bull market is over yet, but in our opinion it seems unlikely. By looking back at the 1995-2000 period on the NDX, we can see that once the market broke above the major diagonal resistance, there were lots of 10-20% corrections and retests of that diagonal. This time around we’ve only tested the diagonal twice and this the largest correction out of the four that have occurred and were larger than 10%. The only index out of the three that is indicating major issues, is the Russell.
Another very important index that isn’t tracking the performance of stocks, but is tracking the volatility of the stock market is the VIX. The VIX can give us a lot of information around fear, uncertainty and change, based on the levels it is trading at and based on how it’s moving. Generally speaking, when the VIX is trading below 16, there is little uncertainty, fear and change, when the VIX is trading 16-32 things there is change, however fear and uncertainty are at moderate levels, while with VIX above 32 there is a lot of uncertainty, a lot of fear and things are changing rapidly. The higher the VIX, the more intense the sentiment on the market. During this correction the VIX got up to 39, which historically is pretty high and was even higher than the 36-37 zone which has as acted as ‘resistance’ on the VIX several times in the past. Although this could be the top for the VIX (bottom for stocks) like in Dec 2018 when the Fed was hiking rates, in our opinion it isn’t and we expect 48-50 to be the top for VIX (bottom for stocks). There are several reasons behind this thinking and a lot goes back to the Fed, the economy, etc, most importantly however, it has to do with the psychology of the market. We feel investors haven’t been scared enough in order to fully capitulate and be shaken out of their longs, neither is the Fed cornered enough to do a 180 turn yet. With so many things changing in the world it doesn’t make sense for volatility to be so low and that at some point as the Fed is raising rates, something could break and cause significant panic. One thing to keep in mind is that in case of severe economic weakness and rapid drop in the inflation rate, then the Fed could use that as an excuse not to raise rates before the market forces them to stop. In that scenario the VIX might topped for a very long time at 39, as the markets will assume the Fed has their back and they don’t have to worry about higher interest rates.
During the GFC the VIX peaked at 95 and during the Covid crash at 85. Back then once it got down to 15-16 it had two spikes up to 48, while this time around it has remained lower with most peaks below 40. Of course, 39 is a perfectly reasonable top for 2022, although we don’t see a way that the Fed hikes 3+ times without at least one of them creating significant panic. Last point on the VIX and stocks broadly, is that it looks like it has formed a significant bottom throughout 2021 and that it currently has a proper long term bullish structure. It’s pretty rare to see it form significant higher highs and higher lows, which could be seen as a sign that there is at least another leg up. Maybe go down to 18-22, test the yearly Pivot & the major moving averages, and then pump.
Note
As we had explained above, stocks rallied by another 5% and then got rejected, at the key levels that were expected. The only one we hadn't zoomed in was Russell which found resistance at a major breakdown level that we hadn't mentioned.As the VIX got down to 18-22 it was normal to see a correction in stocks, as the VIX dropped down really fast, yet there are still lots of things going on all over the world. Over the last few days we've had several major companies show significantly slower growth than expected and this has cause the stocks of those companies to drop a lot. Facebook for a example had a 25% gap down, a move that we last saw in July of 2018, when the price of the company kept dropping until the Fed made its pivot.
Therefore we are still cautious. Despite the major bounce in stocks off major support, it is clear that their trend has changed. Even if it hasn't fully changed yet, we might be in an environment similar to late 2014 to early 2016, or early 2018 to late 2018.
Note
Stocks are increasingly trading like altcoins more recently, with many massive moves up or down after earnings and during after hours. Yesterday Snapchat and Amazon had massive moves up, which however don't look all that sustainable. On the one hand both companies and many others have filled major gaps or retested key breakouts which are short term bullish, yet their structure is bearish or neutral at best.The Nasdaq 100 has dipped again, but it is close into support and the 300 DMA. Therefore we could get a push up to 15500 before we see it roll over again, so that the market can have a proper bull trap. Immediate continuation down seems less likely but clearly not impossible. Of course we can't rule out further upside and even new ATHs in 2022, but like we mentioned above it is more likely that we get some sort of sideways choppy market, with potentially several US tech behemoths continuing higher alone.
One thing we should be aware of now, is that it isn't just the Fed talking about hiking rates or actually hiking rates. More Central banks are joining them, with the recent addition being the ECB. The Fed, ECB, BoE are some of the major ones that have started or will soon start, and this has already caused some issues to European stocks which prior to this held up very nicely. That's because bond yields in Europe have had major rallies, while Europe is facing severe debt issues and the entire market has been optimized for low rates. So as the Euro rallied hard along with bond yields, European stocks took a beating and are looking pretty weak in the short term. On the one hand now markets have already priced in hikes two hikes for the ECB, but it is unlikely that they will be able to raise rates more than twice. Last time they raised rates twice was in 2011 and then quickly stopped and reversed course. The low interest rate trap is real and it is very hard for one to get out of it, therefore we think it is quite likely that the ECB could be the first one to stop raising rates and issues to start from Europe rather than the US. Overall the more Central banks start raising rates and especially the higher energy prices go, the bigger the potential issues we might have for stocks. However for now we could see stocks do well as rates are still low and support for markets is still ongoing.
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