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Hawkish Fed Jolts Stocks
The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Investors were optimistic that the worst of the omicron variant would soon be behind us as the New Year kicked off, but hawkish comments from the Federal Reserve midweek bashed the celebration. The major averages surged into the week with the DJIA and S&P 500 posting new record highs in a broad based rally that saw money flow into every sector. Helping the NASDAQ to outperform was a +13.53% spike in shares of EV maker Tesla (TSLA) after announcing deliveries were up +71% YoY, and Apple (AAPL) briefly topping the $3 trillion market cap. Gains in energy, industrials and banking shares helped lift the Dow Jones to another new high on Tuesday, but the NASDAQ wilted on selling in big cap technology names as traders waited on the minutes from the December FOMC Meeting. The Fed surprised investors with a more hawkish outlook on tapering and rate hikes in the minutes on Wednesday sending equities sharply lower and rates higher. The NASDAQ bore the brunt of the selloff tumbling -3.34%, its biggest one-day percentage loss since February 2021. The different indexes drifted lower to close out the week as market participants rotated out of growth and technology and into cyclical and old economy stocks. Investors moved aggressively into Energy (XLE), which surged +10.52% during the week as crude oil prices flirted with $80 a barrel, last seen in January 2021. Financials (XLF) gained +5.43% on a steepening yield curve and both the Energy and Financial sector ETFs were able to post new highs. The Industrial (XLI) sector also outperformed and was close to a new all-time high as the period ended. Conversely, rate sensitive REITs (XLRE) was the worst performing sector followed by losses in Technology (XLK) and Healthcare (XLV), all down more than -4%. Yields were moving higher, reaching their highest levels since March 2021 with the 30-year T-Bill rate closing at 2.119% and the 10-year yield at 1.772%. A disappointing jobs report on Friday kept pressure on the market ahead of the weekend. The Santa rally mostly lived up to its name, but unfortunately, Fed Chair Powell played the Grinch and the major averages closed out the first week of the New Year lower and the DJIA and S&P 500 snapped a two-week win streak.
For the period, the DJIA slipped 106.64 points (-0.3%) and settled at 36231.66. The S&P 500 fell 89.15 points (-1.9%) and closed at 4677.03. The NASDAQ dropped 709.07 points (-4.5%) finishing at 14935.90, while the small cap Russell 2000 gave up 65.50 points (-2.9%), finishing at 2179.81.
Market Outlook: The technical condition of the market deteriorated this week despite the Dow Jones and S&P 500 setting new record highs early. The technical indicators have shifted to a negative slant with MACD, a short-term trend gauge, bearish. Momentum, as measured by the 14-day RSI, is neutral to negative and the new highs recorded by the Dow and S&P 500 were not confirmed by this indicator. Through Friday the DJIA and S&P 500 were the only indexes holding above their respective 50-day moving average (MA), a key support level. However, support areas have been violated by the NASDAQ, DJ Transportation Index and small cap Russell 2000 which could lead to more weakness. The NASDAQ closed below its 100-day MA, while the Russell 2000 trades below both its 100 and 200-day MA’s. As the week ended the different indexes had held above their December lows, but a break below those levels could induce more selling. If the December low doesn’t hold for the NASDAQ a test of its 200-day MA would come into play at 14680. Finally, weakness in the iShares NASDAQ Biotech ETF (IBB)continues to show negative divergence falling this week to its lowest level since November 2020. There is also negative divergence evident in underlying breadth. The NYSE and NASDAQ Advance/Decline lines, leading indicators of market direction, are both moving lower, and the NYSE A/D line last made a new high on 11/08/21. Finally, new lows are regularly outpacing the number of new highs and the NASDAQ has only had three sessions since 11/17/21 that the index put up more new highs than lows. This all points to a narrowing in leadership in the recent rally and a top-heavy market. Investor sentiment is mixed. While the latest American Association of Individual Investors (AAII) survey showed a reduction in retail bullish sentiment, according to the National Association of Active Investment Managers (NAAIM), institutional investors are more bullish and increased exposure to equities over the last week, now at 89.5%. Hedge fund exposure to equities was only 52.2% mid-December.
This week’s somewhat surprising, faster change to monetary policy by the Federal Reserve in response to soaring inflation sent stocks reeling. Historically, the stock market reacts quickly to the shift in policy and sells off as traders move to more defensive positions as they watch how the pace of rate increases plays out. This week was no different. However, looking out a few months, rising rates have not always hurt stock returns. Since the 1990’s there have been six periods where yields nudged higher, and the stock market has risen in all but one. That may seem contrary to some analysts on television, but because accelerating economic growth pushes earnings higher, higher rates don’t always mean lower stock prices. It’s impossible to predict how the Fed’s plan will affect the market this time, but the economy is strong and moving into cyclical stocks should help investors weather choppy trading. Still, investors should remain cautious until stock valuations reset and the major averages have put in a bottom.
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 +12, unchanged from the previous week. Cycles B, C, D and E are bullish, while Cycle A is bearish. The CTI is projected to remain positive for a few at least one or two more weeks.
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 Neutral at +3, unchanged from the previous week. Breadth was mixed at the NYSE as the Advance/Decline line lost 1031 units while the number of new 52-week highs exceeded the number of new lows on three of the five sessions. Breadth was negative at the NASDAQ as the A/D line lost 4753 units while the number of new lows out did the new highs on three days. Finally, the percentage of stocks above their 50-day moving average rose to 50.2% vs. 48.7% the previous week, while those above their 200-day moving average eased to 52.2% vs. 53.5%. 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 markets 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 Neutral at +1, unchanged from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 1/05/22 shows inflows of $9.2 billion.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Bullish as of the week ending 7/30/2021 (DJIA – 34935.47).
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