Bulls Battle Back

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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).

The major averages turned in their best gains since the last week of June as Q2 earnings came in less bad than feared, and weak economic data sent the yield on the 10-year Treasury lower. Looking to build off last Friday’s rally, stocks gapped up on Monday on solid earnings from Goldman Sachs (GS), but a warning of slower hiring and spending from Apple Co (AAPL) wiped out the gains and left the market in the red. Investors focused on earnings and a report that the European Central Bank (ECB) was going to raise rates 0.50-point later in the week to fight inflation roused the Bulls on Tuesday and equities surged into the close with the DJIA finishing with a 754.44-point (+2.43%) gain, its biggest one-day advance since June 24. Earnings from Netflix (NFLX), Tesla (TSLA) and others on Wednesday and Thursday kept the rally going and the different indexes closed at their highest levels since early June. The rally paused on Friday after Snap (SNAP) and Twitter (TWTR) disappointed and lowered forward guidance, while a contracting Services PMI renewed recession fears. Slower growth prospects weighed on crude oil prices which finished the period back below $100 a barrel at $4.63, but commodities were able to bounce on Friday led by a surge in energy prices with Natural Gas Futures rising +14% during the week. Wheat futures however dropped -6.29% on Friday after Russia and Ukraine agreed to release Ukraine grains. Yields moved lower on recession fears and the rate on the 10-year Treasury landed at 2.77%, its lowest mark since May, while the 2-year slipped back below 3% on Friday on speculation that the Federal Reserve could pause their tightening cycle after July’s 0.75-point hike. Leading the market higher were gains in the Consumer Discretionary (XLY), Materials (XLB) Energy (XLE), Industrials (XLI) and Technology (XLK) sectors, all up more than +3%, while only Utilities (XLU) and Healthcare (XLV) closed the period lower. The bulls looked winded on Friday but closed the week with solid gains across the board.

For the period, the DJIA gained 611.03 points (+2.0%) and settled at 31899.29. The S&P 500 picked up 98.47 points (+2.5%) and closed at 3961.63. The NASDAQ jumped 381.69 points (+3.3%) finishing at 11834.11. The small cap Russell 2000 added 62.51 points (+3.6%), finishing at 1806.88.

Market Outlook: The technical condition of the market improved this week as the different indexes were able to break through key resistance and finished at their highest levels in seven weeks. The technical indicators returned to a bullish configuration with MACD, which gauges the short-term trend, crossing into bullish ground, while Momentum, as measured by the 14-day RSI, moving positive. The DJIA, S&P 500 and NASDAQ broke above descending trend lines off the April -June highs and have retraced more than 50% of the June high-to-low selloff. Usually after a stock or index retraces more than 50% of a move in a short time period it will retrace the full amount which brings the June highs into play. Another positive is that the major averages are all trading back above their 50-day MA for the first time since April. Momentum looks strong enough for the DJIA to rally to 33150-33250, while the S&P 500 looks headed to 4150-4200. The NASDAQ target is 12350. Those numbers also closely align with the respective 100-day MA of the indices providing another layer of resistance. Market technicians will often look at weekly charts for signs of positive or negative divergence when analyzing longer-term trends. As the week ended the weekly charts have improved but are not showing signs that the current rally is much more than a bounce in a bear market. MACD on the weekly charts is close to or has crossed into positive ground, but Momentum is neutral and the 14-week RSI remains below the midpoint line, but is rising. The secondary indexes, including the DJ Transportation Index, small cap Russell 2000 and Philadelphia Semiconductor Index, which tend to lead the market higher and lower, are showing positive divergence which helps solidify that the major averages will rally to at least the June highs. Underlying breadth greatly improved this week with the NYSE and NASDAQ Advance/Decline lines sharply higher showing broad participation in the current rally. In addition, the number of new 52-week lows contracted to double-digits this week after hitting mid triple-digit numbers previously. Investor Sentiment also saw an uptick among the bulls. After reaching extreme levels of bearishness, according to the American Association of Individual Investors (AAII), retail bulls nudged higher, while the National Association of Active Investment Managers (NAAIM)Exposure Index jumped to 44.5% from 26.7% the previous week meaning hedge funds are adding to equity exposure here.

Stocks were able to rally this week as earnings held up, and economic data showed the Fed’s tightening policy may not send the economy into a recession. Friday’s numbers, however, came in worse than expected with the Services PMI in contraction for the first time since April 2020 refueling recession fears. In addition, forward guidance for earnings is mixed with several big technology companies warning higher rates and inflation will weigh on results during the second half of the year. While several analysts are implying that the Federal Reserve could pause raising rates in September, if may be wishful thinking. Fed Chair Powell and Committee members have a mandate to return inflation to the 2-3% level. I think it is unlikely that another 0.75-point hike in July will accomplish that goal leaving the door open for additional increases as the year progresses. We saw in Snap’s (SNAP) earnings call on Friday how fragile growth stocks are to a combination of higher rates and slowing growth. For that reason, although I think the market can trade higher over the near-term, I believe investors need to remain cautious and consider this week’s rally a bull bounce in a bear market.

A chart of these indicators can be found by going to the Market Edge Home page and clicking on Market Recap, which is on the right-hand side of the page just below the Second Opinion Status numbers.

Cyclical Trend Index (CTI): The underlying premise of the CTI is that the market, as measured by the Dow Jones Industrial Average (DJIA), tends to move in cycles that often resemble sine waves. There are five identifiable cycles, each with different time durations at work in the market at all times.

Currently, the CTI is Positive at +6, unchanged from the previous week. Cycles B, C and E are bullish, while Cycles A and D are bearish. The CTI is projected to remain positive into August.

Momentum Index (MI): The market’s momentum is measured by comparing the strength or weakness of several broad market indexes to the DJIA. Readings of -4 and lower are regarded as bearish since it is an indication that a majority of the broader based market indexes are weaker than the DJIA on a percentage basis. Conversely, readings of +4 or higher are regarded as bullish.

The Momentum Index is Positive at +8, up three notches from the previous week. Breadth was mixed at the NYSE as the Advance/Decline line gained 3651 units while the number of new 52-week lows exceeded the number of new highs on all five sessions. Breadth was also mixed at the NASDAQ as the A/D line added 3131 units while the number of new lows out did the new highs on each day. Finally, the percentage of stocks above their 50-day moving average jumped to 55.3% vs. 23.9% the previous week, while those above their 200-day moving average rose to 19.8% vs. 13.5%. Readings above 70.0% denote an overbought condition, while below 20% is bullish.

Sentiment Index (SI): Measuring the market’s Bullish or Bearish sentiment is important when attempting to determine the market’s future direction. Market Edge tracks thirteen technical indicators listed below that measure excessive bullish or bearish sentiment conditions prevalent in the market. The Sentiment Index is Positive at +4, down two notches from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 7/20/22 shows outflows of $10.4 billion.

Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Bullish as of the week ending 6/24/2022 (DJIA – 31500.68).

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