I think the most interesting development this week is that oil prices are heading down again, with lower Lows confirming the continuation of the long-term downtrend and discounting a recessionary period for the economy.
There is a lot of talk about how the Fed will proceed, now that more economic indicators have come in to show weakness creeping into the economy, such as production. I have been talking for a while about how weakening consumers and producers are not ‘new’ news, as other metrics (e.g. inflation-adjusted retail sales) have been showing contracting activity for a while. Whatever the central banks cook up next, it is unlikely to move the market up in the short-term picture.
General market is thin
Let’s look at the market. “Overbought and thin” is how I would summarize the current environment – definitely a winning recipe for shakeouts. Volatility has reigned supreme the last few weeks, although volume was muted the last week partially due to the long weekend.
The elephant in the room is that this market is extended … from many perspectives. The DJIA industrial index only needs to gap up less than a percent higher on Monday to achieve a 20% rally from the bottom for some people to jump on the ‘The-New-Bull-Is-Here’ bandwagon again.
As discussed in previous reports, the NASDAQ and classical growth sectors have been lagging in this rally, while the DJIA and the SPX to a slightly lesser degree have marched on relentlessly. Rally volume had been retreating earlier in the week, even before the long weekend – not a great sign after such a prolonged bear market. Now, the DJIA and many of its components and other industrials are massively extended. Just check a chart of IBM, HON, CAT, or GS. The higher such rallies go uninterrupted, the longer they need to digest to stay healthy.
Friday, DJIA made a higher High in price than the August rally, marginally, tepidly. This has not been confirmed by any other relevant index (popular or otherwise, not even the DOW transports), and the Dow theorists among you will cry foul if this remains so over the next 1-3 weeks. We are at a decision point.
Equally, the SPX is 6% extended over its 50DMA, and sitting just below its downtrend line and its 200DMA – resistance zones since the beginning of the bear market.
The NASDAQ is hovering above its 50DMA, and is actually in somewhat of a good digestion period – even the volume profile has been quite bullish here. Again, the question can be raised whether support will hold and NASDAQ will move up further, or whether it will roll over. As alluded to before, the lack of reliable leadership and other supporting factors lead me to believe that the latter will take place.
To summarize, the DJIA is still extremely overbought in the intermediate-term and the short-term trends, while the SPX is showing the same dynamics to a lesser degree of intensity. Looking at historical precedent, the odds are 1:2 against seeing significantly higher prices in the next few weeks, but it is possible that we will see some more sideways action before a reversal. On the other hand, I would also not be surprised by a sudden selloff given the recent volatility.
So much for the technicals. Let’s look a bit under the hood.
Big money is in selling mode
The SPX has shown renewed institutional selling soon into this rally since late October, clocking raised volume on a lower Close on 8 days within the last 5 weeks. The market is still led by oil & gas stocks, insurance companies, healthcare, and consumer staples. Both are not what I want to see for a durable rally.
As stated above, digestion in a controlled pullback has to occur if this rally was to go anywhere. However, for such a scenario I would also need to see strong leadership evolving. There’s really not a lot of that, and market breadth remains weak. There are twice as many daily New Lows as there are New Highs, and barely 53% of stocks are trading above their 150-day moving average – both showing a bearish divergence when compared to the summer rally. This is a weak profile, and is – mind you – observable here after rallying for 1.5 months – hardly a bullish environment. Market complacency is still high and appears unnaturally entrenched, which is almost unbelievable given the massive declines on NASDAQ and the last two year’s leaders.
Individual stocks chop around
Stocks that had acted stronger recently, such as ASO, ANET, GFS, HALO, ACLS or ENPH, are all struggling staying at or near new Highs. I’ve not been chasing any of them. All of them either resolved negatively on miserable volume within digestions, did not digest properly, are now wedging/drifting upwards on feeble volume, or failed to attract follow-up buying after moving out of digestion patterns. I should say they were “limp-outs”.
Specifically, the lagging and questionable action of high-quality ENPH, GFS, and ANET so late in this rally leads me to believe that we are far from being out of the woods.
Steels and oil don’t go anywhere
Even for commodity stocks that had held up well continuing from the 2021 rotation into cyclicals, price-volume action is of limited beauty. Steels such as NUE or STLD are fizzling out quickly on their attempted range-breakouts or when trying to move out of digestions, and oil & gas stocks at large are suffering from shakeouts and lack of volume – likely experiencing friction with the declining oil prices.
Some silver lining
On the (limited) upside, FSLR is still on steroids, marching on beautifully but it is strongly extended and the receding volume suggests that a digestion is necessary. FSLR and ENPH are, in my opinion, the two best stocks in the solar industry and probably the whole market. The solar industry as a whole is one of the better-performing groups – have a look at SHLS and ARRY, two fundamentally stellar stocks that are showing strong price action. ARRY has strong overhead supply in the past. Neither of them is actionable for me right now, but I will keep a close eye on them
Remain patient
That handful of stocks doing well though is just not enough to stabilize the market for a sustainable trend.
I am further concerned about the leadership dominated by stocks such as IBM, PEP, GIS and other food stocks, fast-food chains such as MCD & QSR, discount retailers TJX, CASY, etc. One look at the Staples ETF XLP shows me that speculation ‘du jour’ is nowhere exuberant, but rather like suffering from a hangover.
Over the next 1-3 weeks, I do expect an imminent reversal and prices heading lower again … unless strong and durable leadership comes out of the woodwork.
There is a clear lesson here. Patience will reward you, and buying into overbought and rotational markets expecting a significant upside will cost you. As alluded before, such (largely short-covering) rallies are tradeable, but the upside is limited. I will tread with care.