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The Week On Wall Street – The Bulls Mount A Challenge (SPY)


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“The erosion of our confidence in the future is threatening to destroy the social and the political fabric of America.” – President Jimmy Carter 7/15/79

43 years ago, President Carter addressed the nation in what has become the now famous crisis of confidence speech. Today, we find ourselves in a very similar situation with rampant inflation and sentiment among Americans at multi-decade lows. 92% of Republicans and 78% of Democrats are dissatisfied with the direction of the country — the highest number among Democrats since President Biden took office last year. Reading through Carter’s speech today, you would have thought he was talking about the present-day United States. Unfortunately, from an economic perspective, Carter’s speech was followed by two separate recessions (the double-dip) in the next four years. The first started five months later in January 1980 and lasted just six months. The expansion that followed lasted only a year, and in January 1981 a second contraction began lasting 16 months in what at the time was tied for the longest recession since the Great Depression.

The Michigan Confidence index is at lower levels now than it was when Carter gave his ‘malaise’ speech and for that matter, at any time since the survey started in the late 1970s. As we all remember, in the preliminary release of that report last month, inflation expectations ticked higher leading to a more aggressive rate hike from the Federal Reserve. Those expectations were confirmed when the June Inflation numbers were reported recently.

Carter’s ‘Crisis of Confidence’ speech focused a lot on high energy prices and his proposals to help reduce the US dependence on foreign oil. Ironically, President Biden finds himself in the same boat. The administration’s “New Green Deal” was launched and now the ship (US economy) is sinking.

Investors are rightfully feeling exhausted. A complete loss of consumer confidence, inflation wreaking havoc on budgets, the stress of predicting the Fed’s next move, the fears of a recession, and the anticipation of a less optimistic earnings season have weighed on market sentiment. We’ve also had to fight through the worst first six months for stocks in half a century. The worst year for bonds since 1933, and the highest inflation in 40 years. In dollar terms, U.S. equities have shed $14 trillion so far this year, exceeding 2008’s $11 trillion declines. Along with fixed income and crypto losses, cumulative wealth destruction is huge. If you have been able to keep your head above water and limit the pain, that is quite an accomplishment.

Two factors have played a huge role in the swings of asset markets over the last few months: expectations for economic growth and expectations for the path of interest rates. Typically, these have been correlated, but the decline in growth expectations despite further hawkishness this summer has been an example of how they don’t always move in lockstep.

The PROs

The real question de jour is;

“Has the stock market already discounted another one or two interest rate hikes?”

The BULLS will cite their reasons to remain optimistic. Monetary policy while in the process of change is still not restrictive. The consumer enters this slower growth period in excellent shape. They are not “stretched” like they were in 2007/2008. High inflation does not automatically curb growth by reducing real wages. The reduction in real wages due to inflation has been more than offset, at least until very recently, by the strong growth of employment. As a result, aggregate wages and salaries have grown by 12.4% in the past two years, higher than inflation.

While Inflation still has some “sticky’’ hurdles to clear, (especially if energy costs remain elevated) BUT they rattle off their reasons why they believe it has peaked. They are betting the Fed will back off, making a “soft landing” more likely.

China will fully unlock its economy by the end of this year, or early in 2023. Since China now has a bigger GDP than the US, when measured at purchasing power parity, the resulting boost to global economic activity and trade could match that of the 2021 US reopening boom.

The CONs

The BEARISH arguments are just as convincing. This present backdrop looks like a replay of the 70s. The Fed will tighten enough to spark a recession but not enough to crush inflation. The worst of both worlds. Inflation “peaked” three times that decade, pulling off highs for a while and spawning market runs, only to resume climbing to even higher highs in each case, taking stocks down with it.

While there may not be “runaway inflation”, the Fed is still in a quandary. Monetary policies typically take a year to have an impact and we are just five months into this cycle, leaving questions as to how much impact these rate hikes will have on the economy down the road.

Even with recent slowing, headline and core inflation look to remain above Fed targets this year and next. The lockdowns, $5.3 trillion of fiscal stimulus, $1.8 trillion of liquidity injections into the banking system, and Fed bond purchases can’t be quickly reversed. Then there is the “energy cost” situation. Anyone dismissing the fact that there is no help on this issue is committing financial suicide. IF spending and raising taxes continue to be the cornerstones of “policy”, anything is possible. In this context, ‘anything’ equates to a prolonged inflation-driven recession.

Market participants are in the process of trying to figure out what evidence is more viable and which carries more weight to the BULL/BEAR arguments. The one fact that remains in the spotlight. We have the FED in the picture, raising rates to fight inflation in a slowing economy. Some might argue that trumps everything.

In the meantime, the major indices have been treading water recently and despite the continuing bad news on inflation, they remain above their respective June lows and are now challenging overhead resistance.

As the picture shows, nothing has changed. The BEAR is on high ground, while the BULL has an uphill road.

The Week On Wall Street

This year the market has possessed a tendency to kick off the week on a down note. Consider this, including last Monday, of the 29 weeks so far in 2022, the S&P 500 has only opened higher on the first trading day of the week ten times. The S&P opened with a flourish this week then fizzled out as “resistance” claimed another victim. The index neared the next resistance level, reversed and the selling intensified as the session continued. The S&P closed down 0.83% at 3831. That amounted to about an 80-point swing in the index and was another frustrating, disappointing day for the Bulls.

“Turnaround Tuesday” arrived and the BULLS picked up their “fumble” from Monday, and it was time for the BEARS to be frustrated. All of the indices moved higher with the S&P up 2.7%% and settling above short-term resistance levels.

Once short-term resistance was overcome the Algos kicked in and the buying spree continued until trading closed on Thursday. The trading week closed out on a sour note for the BULLS with profit taking and a cautious stance from traders heading into the weekend

For the week the S&P 500 rallied 2.5%, while the Nasdaq moved 3.3% higher. However, it was the Russell 2000 small caps that gained the most ground with a 3.6% rally this week.

The Economy

Initial Jobless claims released this week are trending higher. The recent increase in claims off the March lows has been larger than the increase in claims that have been typical in the year leading up to the start of recessions.

This doesn’t mean that the economy is in a recession, but just because initial claims are seemingly low doesn’t mean a recession is out of the question.

The Conference Board’s Leading index dropped 0.8% in June to 117.1 after dropping -0.6% to 118.0 in May and -0.5% to 118.7 in April. This is a fourth straight monthly decline and the lowest level since last July at 116.6. The index was at a record peak of 119.4 in February. Six of the 10 components made negative contributions, led by consumer expectations (-0.37%), the average workweek (-0.17%), jobless claims (-0.15%), and stock prices.

The only time Leading indicators dropped as much as this June and with the economy not on the verge of a recession (within a year) was in January 1996. In all other instances, this sort of leading indicator decline meant recession. If the economy does enter recession, it will surely be one of the most obvious in American history. While there is a chance recession is avoided, it’s hard to come up with an indicator that has not signaled imminent recession risk either recently or over the past few months.

Housing

NAHB housing market index plunged 12 points to 55 in July after the 2-point drop to 67 in June. This is the largest point tumble since the 42 drop in April 2020. And it is a seventh straight monthly decline, sliding from a recent high of 84 in December and an all-time peak of 90 in November 2020.

NAHB

NAHB Survey (www.bespokepremium.com)

It is the lowest reading since the 37 from May 2020 and compares to this historic nadir of 8 in January 2009. Homebuilders are facing a double whammy. Surging mortgage rates and declining affordability with prices at or near record peaks are a challenge for home buyers. And rising costs of land, labor, and most materials are weighing on builders, though the HMI report indicated lumber costs have been easing as construction has slowed.

Housing starts undershot estimates with June Starts falling 2.0% to a 1.55 Million clip, after 37k in upward revisions, versus a 16-year high of 1.77 M in February. Building permits fell 0.6% to a 1.68 Million rate, versus a 16-year high pace of 1.89 M in December.

Soaring mortgage rates are impacting starts and permits, alongside the big hit to new and existing home sales, though starts under construction are still tracking a 22.4% year-over-year gain. Completions are still tracking below the path implied by permits and “starts” likely due to material shortages.

Building

Housing construction (www.census.gov/construction/nrc/pdf/newresconst.pdf)

Despite the obvious slowing pace of the industry, note that the trend lines are still either at or above pre-pandemic levels.

Existing home sales contracted at a 37.9% rate in Q2 due to remarkably limited supply and surging mortgage rates, after a 9.1% contraction rate in Q1 but a 9.3% growth rate in Q4. Analysts expect a 5.15 million existing home sales total for 2022, after watching sales come in at 6.12 million in 2021. This translates to an 11.8% drop in 2022, after increases of 8.5% in 2021 and 5.6% in 2020. The housing sector is taking a big hit in 2022 from the direct effect of soaring mortgage rates and the indirect effect of heightened uncertainty about the sector that will continue to restrain the willingness of families to transact in the housing market.

Manufacturing

Philly Fed Index plunged to a 26-month low of -12.3 from a prior low of -3.3 in June leaving the only two negative readings since May of 2020. Analysts saw a 4-month high of 27.4 in March. The ISM-adjusted Philly Fed fell to 48.3 after plunging to 52.6 in June, also leaving the two lowest readings since May of 2020 and a drop in this measure below the 50-mark.

Phil Fed

Philly Fed Index (www.philadelphiafed.org/surveys-and-data/regional-economic-analysis/mbos-2022-07)

That’s an ugly-looking chart BUT there was one bright spot in the report. The “Prices Paid” component fell to 52.2 in July. That’s a sharp decline from a high of 84.6 in April. The Philly Fed’s Prices Paid component is now at the lowest level since January 2021’s reading of 47.4. That is a sign that inflation is slowing.

The Global Scene

The European Central Bank raised its key rate by 50 basis points to 0.5% Thursday, bigger than the 25 bps rate it had previously indicated and marking its first rate hike in 11 years, as it strives to bring inflation down.

“The Governing Council judged that it is appropriate to take a larger first step on its policy rate normalization path than signaled at its previous meeting,” the central bank said in a statement. “This decision is based on the Governing Council’s updated assessment of inflation risks and the reinforced support provided by the TPI for the effective transmission of monetary policy.”

High UK inflation continues, with retail prices rising about 9% annualized in June after soaring throughout the spring. The inflation shock in the UK has been truly historic. This should not come as a surprise; it is right in line with the historic increases in energy costs.

Flash PMIs across a range of countries and both goods and services entered contraction in July data for Japan, Australia, and Europe. We’ll soon find out if these readings represent the lows in this cycle and if so how long will we see activity remain depressed.

U.K.

S&P Global / CIPS Flash United Kingdom PMI – Manufacturing in contraction at 49.7.

Eurozone

Eurozone falls into contraction in July, price pressures ease but remain elevated Key findings: Flash Eurozone PMI Composite Output Index at 49.4 (Jun: 52.0). 17-month low.

Japan

au Jibun Bank Flash Japan Composite PMI

Flash Composite Output Index, July: 50.6 (June Final: 53.0)

Flash Services Business Activity Index, July: 51.2 (June Final: 54.0)

Flash Manufacturing Output Index now in contraction July: 49.5 (June Final: 50.7)

Political Scene

Reconciliation Shrinks Again, Senate Eyes Targeted Semiconductor Funding.

This is a positive for the markets.

The scope of the Senate’s reconciliation package is likely to be pared back to a healthcare-focused bill (removing climate and energy/tax provisions) following reports indicating Senator Joe Manchin (D-WV) torpedoed hopes from the party for a package to address drug costs and alter the tax code. As has been the case since Manchin and his fellow swing voter Kyrsten Sinema (D-AZ) vetoed Biden’s Build Back Better package, we should expect no major legislation on fiscal or economic policy to pass this Congress.

While disappointment among Democrats will be high on the removal of climate provisions, the reality is that the alternative to Manchin’s desired package is no deal. Significant portions of the healthcare provisions are settled, which could accelerate a pathway to a healthcare-focused package.

President Biden’s net approval (-17%) is the lowest in history for a first-term President in mid-July of his second year and is in the 11th percentile of all Presidential net approval ratings since 1945 per FiveThirtyEight. Republicans hold a 1.8 percentage point lead in Congressional generic ballot polling, lower than the mid-2% lead from June but more than enough to win control of the House this fall without major changes.

The Senate passed a procedural vote to advance legislation that targets domestic semiconductor grants and tax incentives. The centerpiece of the legislation is $52 billion to rebuild domestic chip production and tax breaks to encourage the construction of plants based in the U.S.

The next step is for the Senate to pass a final vote on the modified CHIPS Act, which is being called CHIPS plus, and then pass it down to the House. Now we will wait and see what could be “added” to this spending bill before it is finally passed.

The Midterms

Midterm elections are less than five months away now, and with many states completing their primary election process, the official campaigns for the House and Senate are starting to get underway. For the last several months, there has been nearly widespread agreement that Republicans would take back control of the House and Senate, and while the betting markets still expect Republicans to come out on top, it’s far from a ‘sure thing’.

Despite the favored odds in betting markets, polling for swing Senate seats isn’t nearly as strong. Democrats have not trailed in a swing Senate poll (swing seats this cycle are NV, GA, NC, PA, AZ, and WI) since May. Polls cannot be assumed to be correct, but if they were, Democrats would be picking up seats in WI, PA, and NC while successfully defending seats in GA and NV.

One huge caveat here is the recent trend of under-sampling non-college white voters, who tend to vote Republican and have been under-represented in many polling samples over the past decade or so. These campaigns also have a long way to go, but the fact remains that, unlike betting markets, polling looks weaker for Republicans in the Senate.

The same is not particularly true for generic Congressional ballot tracking polls, which are a good predictor of national House vote split. It’s also worth highlighting that redistricting has made the House much less competitive for both parties over the past decade and including the most recent cycle following the 2020 Census. The vast majority of House seats, either blue or red, are simply uncompetitive and do not reflect the national political mood.

So while the GOP would be set to take a House majority with this sort of polling given their more efficient vote distribution, it’s less likely to be a “wave” election regardless of how big vote margins get in Republicans’ favor.

Historically, full Democratic control in DC has been a favorable backdrop for stocks, although that hasn’t necessarily been the case this time around as the DJIA is now barely up since the 117th Congress began in early 2021. This has confounded the “experts” who follow historical results. I guess that in general politicians rarely have that much of an effect on economics and markets. However, what we have learned this time around when policies are “EXTREME” all bets are off.

At this point, many analysts suggest it is very likely to see Democrats hold on to the Senate but lose control of the House. IF that occurs it is also the one combination of party control that’s never occurred in the last 122 years. A very fitting situation given what investors have been laboring under — complete uncertainty.

Earnings

Companies are just dealing with a lot at the moment – high labor costs, high input costs, a slowdown in the economy, inventory buildups, supply chain issues, and an increasingly strong dollar.

The low expectations hopefully set us up for some positive surprises, but we will have to see them first, and so far about 15% of companies are reporting decent results. Going forward, if the numbers disappoint and management teams are resoundingly gloomy, stock prices will likely suffer. Inflation and a slowing economy have been talking points for a while now, but recently they have been joined by talk of a surging U.S. Dollar.

The problem is that I am not sure what is going to bring down the dollar’s strength relative to currencies like the euro and yen. The economies of Europe and Japan are a mess and mostly have been for a long while. There have been intermittent stronger periods for these economies over the past several years but, for the most part, there’s a reason that global investors have regularly flocked to the United States rather than deal with the unique issues facing the other parts of the developed world.

The U.S. has its problems, to be sure, but the fundamental/economic headwinds, relatively speaking, are less fierce than in Europe and Japan. Technically, too, there’s very little standing in the dollar’s way. Not too long ago it looked as if the U.S. Dollar Index was hitting some very strong resistance, but it has since blown past that and looks poised to push higher.

The EUR/USD is now at parity, and the pair is showing no real sign of slowing in favor of the USD. For years, so many people worried that runaway inflation, a by-product of quantitative easing and government stimulus would collapse the dollar. That could still happen over the long run, but for now, it appears to remain preferred to alternatives like the euro, yen, gold, or bitcoin. When we throw the strong dollar into the mix on top of everything else coming up, it does present a real challenge. The USD did slow its ascent this week and perhaps that represents some sort of a peak.

Food For Thought

The Green New Deal

A transition without a plan is a failed transition.

The movement to “all green all the time” is fraught with issues. The latest is that the required infrastructure to support EV fleets isn’t in place yet. EV owners in Texas are being asked not to charge their EVs for fear of sending the power grind into a total meltdown. This is just the beginning of these types of situations, and it will be that way until all of the pieces of the EV puzzle are put into place. This transition will not go as smoothly as some want. For the green movement that won’t be tomorrow or the next day, no matter how hard they pound the table on this transition.

I’m not anti-EVs. I’m pro facts, truth, and the reality of the situation. Forcing the green new deal is going to be detrimental to the economy until the U.S. decides to prioritize, then adopt an “Energy Security” policy again.

Energy costs will remain HIGH and that keeps inflation cemented in place.

Some are taking bows over this recent headline

“The national average price of a gallon of gas has dropped below $4.50 for the first time in over two months.”

Before anyone starts taking credit for anything the facts also show prices are still up 9.3% over the last 3 months, 36.8% YTD, and 42.0% over the last year.

Creating Jobs?

I’ve cast plenty of doubt regarding the claims that hundreds of thousands of jobs have been “created” in the last 18 months. The data clearly shows that people have simply returned to the workforce, and the chart from the Bureau of Labor Statistics confirms that.

The prevailing logic suggests the Green Energy movement has opened up an opportunity for further employment that would not have been there. However, that has come at the expense of the oil industry which is under attack, and that is clearly inhibiting growth. While it would be logical to keep job availability in the energy sector alive and thus actually create jobs elsewhere there is yet another fact that is quite disturbing in this “Green” transition.

Let’s examine some facts. Depending on a variety of factors, the Hourly Wage in the Solar Panel Industry is between $13 and $18 per hour

While the average hourly pay for an oil service worker is $25/ hr., with a range of $18 to $35/hour also depending on a variety of factors. The lower end of the pay scale here is equal to the top level in the solar industry and that doesn’t seem to be “progress” and “growth”.

One also has to question what the green movement is telling everyone with these job creation stories. Ford (F) is another example of how going “green” adds nothing to the total employment picture. While Ford is on a mission to build up its EV workforce, they are also in the mode of dismantling its “combustible engine” division. Where exactly are all of the benefits to the US workforce that this failed green movement claims? This agenda continues to over-promise and under-deliver, and it’s adding to the malaise of the economy.

In a slowing economy with more and more companies announcing a hiring slowdown and/or layoffs, pro-growth initiatives must be part of any economic agenda. Moving to an “Energy Security” platform instead of being reliant on others accomplishes a myriad of positives for growth and security. The Eurozone is facing the harsh reality of being reliant on others right now. Since there is no-change forthcoming on US energy policy, this adds another issue that investors are confronted with when assessing the general economy and recession probabilities.

There are many moving parts in that assessment, but the one constant that is still in place – is higher energy costs. That keeps the Energy sector in play and adds a ball and chain to the economy.

The War Continues

I’m not referring to the Russia/Ukraine conflict, but a conflict here in the US that has already produced dire consequences for the economy. It appears there is no end in sight to this war on fossil fuels that is morphing into a war on the economy itself. President Biden recently promised to take executive action to combat climate change.

“If the Senate will not move to tackle the climate crisis and strengthen our domestic clean energy industry, I will take strong executive action to meet this moment.”

While that may come to pass, the latest Supreme Court ruling on EPA regulations will provide anyone that decides to ignore, then challenge such proposals a huge tailwind to their legal argument.

Environmentalists enraged by Manchin’s move are imploring Biden to declare a “climate emergency,” which could unlock a broad range of executive powers that potentially could allow for shutting crude exports, suspending offshore drilling, and redirecting funds for clean energy projects – while U.S. inflation rages at 40-year highs.

Looking to salvage his environmental agenda, President Biden is seriously considering the environmentalist’s view by declaring a national climate emergency soon, according to the Washington Post. The decision could redirect funds for clean energy projects and restrict offshore drilling, or even curtail the movement of fossil fuels aboard ships, trains, and pipelines. He may also use the Defense Production Act to ramp up the output of renewable energy products and systems.

Any executive action would face the reality of continued high energy costs, as well as a likely court challenge. If acted upon, the administration and other agencies enacting “orders” regarding the climate are going to find their battle is now uphill. The recent Supreme Court ruling that admonished the EPA for “overreaching” its authority clearly states that Congress and Congress alone must enact legislation when it comes to these “regulatory issues”.

The good news for the economy is the anti-business “regulatory” backdrop has been dealt a setback. Cracks are appearing in this regulatory environment that may come to the aid of companies that have been saddled with a heavy burden of regulations. The bad news, a lot of damage has been done and it may take a while before we ever see that rectified.

Don’t think for one minute that institutions suffering through a bad case of buyer remorse, aren’t sitting up and taking notice. Perhaps it’s fed into this recent rally. The more this anti-business agenda can be shredded the better chance the economy can bottom and then start to be repaired.

Sentiment

Speculator positioning in S&P 500 futures contracts continues to collapse with the latest reading from the Commitments of Traders report showing a net 9.3% of open interest short. Dropping another 1.35 % week over week, that leaves positioning at the most net short levels since the first week of October 2015. After that reading was recorded the S&P added 7.5% in the next two months.

The NASDAQ also went through a sharp drop in “long” positioning as open interest went from 11.91% net long to only 7.64% net long in the past week.

We’ve seen investor sentiment positioned to these types of extremes and so far it hasn’t made much of a difference. We’ll soon find out if the net short position on the S&P is the correct “positioning”.

Turning over to commodities, WTI saw the lowest level of net longs since February. On February 1, WTI was at $88/bbl. and ran to the peak of $130, before it started to retrace that gain. I’m not suggesting WTI makes another run at $130, but with the majority no longer involved on the long side it might be a sign that prices will at the very least stabilize around $95-$100.

Another notable report this week was the latest Merrill Lynch Fund Managers Survey which showed widespread pessimism on the part of respondents. According to the report, exposure levels to risk assets were taken down to their lowest levels since the Financial Crisis while cash levels are higher now than at any other time since 2001!

It’s one thing to declare an opinion, but we now see “positioning ” showing no one wants to be in this market. There is plenty of evidence that we have reached a MAX BEARISH level on sentiment. This may be the time when this negative tone starts to line up with other indicators I’m watching, it may signal a genuine bottoming process is in full swing.

The Daily chart of the S&P 500 (SPY)

A very short-term stair-step pattern emerged this week, and it came at an opportune time for the BULLS.

S&P 500

S&P 500 7-22 (www.FreeStockCharts.com)

The rally paused on Friday and now investors have to wonder if this move will have any “staying power”. The BULLS are looking for a move to the next resistance level, while the BEARS are saying this is nothing more than another BEAR market rally that is ready to fizzle out.

Investment Backdrop

The major averages have not made new lows in almost a month and breadth readings have improved from where they were at the start of July. There have been five 80-90% upside days since June 24 (the latest one this week) with zero 80-90% downside days. I’ll also note that while the S&P has sent many positive and negative short-term messages recently it has gone nowhere since May 12th.

Since mid-June, we’ve seen a 9% rally, a 5% giveback, and another 5% rally followed by yet another 5% pullback. This week we can now add another 5+% gain to the list. This short-term trendless market has wreaked havoc on investors’ emotions. It has been an extremely difficult market to navigate.

While the fundamentals are questionable and unreliable now, what I can rely on is the technical side of the equation and stay focused on price action. It is a redundant theme but one that gives us the best chance of navigating the markets now. Yet I find so many investors these days that are not paying attention to what the market is saying.

There Is More To Consider

This year investors face another challenge. The wild card I mentioned earlier is called the Mid Term elections and what typically occurs in mid-term election years and it offers a unique set of circumstances. The weakness of equities during midterm election years is evident by the median size of the maximum drawdown in all years versus mid-terms only. In a typical year, the S&P 500 sees a drawdown of just under 11%, but in mid-term years, the median peak to trough decline is closer to 18%. We’ve had that and more.

In terms of the S&P 500’s typical pattern during mid-term years, there’s good news and bad news. The bad news is that the S&P 500 typically doesn’t bottom until early October, and the low of the year takes place in the second half of the year in over 42% of all prior mid-term years.

While seasonal trends suggest further headwinds for stocks heading into the second half, the good news is that the magnitude of the ‘typical’ decline from here is small, and the year tends to close off on an extremely positive note as well. There are no guarantees this year, but that history tells me the probability of a market rebound is higher after the November elections.

Let me remind everyone what the historical models also suggest. With no recession and the stock market being down 20+%, the bulk of the decline has been baked in. Add recession to the mix and the average decline jumps to 35+% for the S&P 500 and the duration of the event is twice as long. So while we can argue over the official designation of recession/no recession, it will more than likely come down to the depths of a slowdown.

The backdrop described in the opening paragraphs of this missive is real. It isn’t contrived, nor is it made up of “opinions”. Quite frankly, it’s the reason the primary trend of the stock market today is BEARISH. There are “green shoots” appearing in recent price action. Identifying them is one thing, taking advantage of them is quite another.

Thank you for reading this analysis. If you enjoyed this article so far, this next section provides a quick taste of what members of my marketplace service receive in DAILY updates. If you find these weekly articles useful, you may want to join a community of SAVVY Investors that have discovered “how the market works”.

The 2022 Playbook is now “Lean and Mean”

Yes, that is correct, opportunities are condensed in Energy, Commodities, and Healthcare. Along with that I’ve defined Bearish to Bullish reversals in three other areas of the market that have led to massive gains (30+%) in the last 6 weeks. The message to clients and members of my service has been the same. Stay with what is working.

Each week I revisit the “canary message” which served as a warning for the economy. The focus was on the Financials, Transports, Semiconductors, and Small Caps. I used them as a “tell” for what direction the economy was headed to help forge a near-term strategy. With the major indices showing some signs of stabilization, it might be a signal that is now lining up with the “consensus” view of a “mild recession”.

I’m not there yet but if the price action tells me that, I will gladly reconsider my forecast.

Small Caps

The Russell 200 small cap index as measured by the IWM has remained more in a sideways pattern since mid-June. The price action has been encouraging in that the index has bounced off a support level that coincides with the February 2020 highs. That’s daily important and it looks like an index that is in a full-blown bottoming process.

Sectors

All sectors that are in BEAR market trends have come well off their June lows and are now headed to a battle with overhead resistance. Only Energy and Healthcare remain in BULL mode.

Energy

The energy sector (XLE) is up 23.1% on a YTD basis, whereas the S&P 500 (SPY) has declined by 19.3%, resulting in a relative strength reading of 52.4 percentage points. At the peak on June 10th, XLE had outperformed SPY by a whopping 94.8 percentage points, so the pullback has been dramatic, but not unwarranted, to say the least.

While the Energy sector may have broken support at its 200-Day moving average on an intraday basis, it has bounced back and is right around two other potentially important levels. Unless WTI completely falls apart, this area of support for XLE looks solid. That does make perfect sense when Russian exports of oil are slightly higher than what they were before the war. So despite the spike, and the subsequent “give back” this long-term uptrend has not been disturbed.

Energy Overreaction

The “Resources” sectors (Energy + Materials) just experienced their largest outflows ever according to Bank of America. This “trade” is still not as accepted as it should be and that raises the prospect that we have an investment opportunity. Nothing has changed in the underlying fundamentals in these sectors.

Looking at crude oil in particular; Unless the policy error that has released reserves from the Strategic Petroleum Reserve is going to take the reserve to zero, eventually, this trend reverses. The SPR is being drawn down BUT will eventually have to be replenished.

SPR

Strategic Petroleum Reserve (www.energy.gov)

In the meantime, OPEC+ continues to miss production quotas and is now more than 2.6 million barrels of oil per day below their target, and Energy Capex spending has plummeted over the past few years even as prices have skyrocketed since 2020.

saudi production

OPEC production (www.opec.org)

Where exactly is supply going to come from in the future? Barring a devastating depression or another total global shutdown (the latter is a LOW probability event), it still looks like the supply/demand picture supports stable and/or higher oil prices. The Saudis confirmed their production status by stating they are at capacity and will target a production increase of 1 million barrels/day by 2027.

The Saudis also sent a message, and it echoes what those who have been realistically viewing the energy crisis have been saying; the green movement has to be “checked”. Unrealistic energy policies are going to lead to unprecedented inflation. Yet, it appears not many are listening.

Unless the US adopts an “Energy Security” mindset this energy crisis persists. The alternative is a deep global recession (The WILD CARD) which brings a host of other negatives along with it, the least being lower oil prices.

Commodities

There is a theory that since “commodities” have pulled back, these “input prices” signal inflation is getting ready to roll over.

Agricultural commodities are now 20% off their peak, matching energy and precious metal commodities, respectively. This comes as speculators begin to question the demand side of the equation due to recessionary fears.

That view has some merit, BUT the counterargument suggests these pullbacks are well within the norm. They have simply followed the price of oil and the “war premium” has been removed. The long-term trend lines which show many commodity ETFs remain in BULLISH uptrends seem to bolster that view.

Agriculture (DBA), GSCI Commodity ETF (GSG), and Invesco Commodity ETF (DBC) are all in long-term uptrends that have not been broken. This could be a correction in sectors that have had huge rallies and are not signaling inflation is going to slow dramatically in the short term.

Some of the base metal ETFs have broken support but they are invested in an array of metals that have broken down and are not representative of what can be deemed “input prices” that affect inflation.

Similar to crude oil – the WILD CARD will be how traders view the possibility of a global recession, and just as they overshot to the upside perhaps they overshoot to the downside. However, until I see long-term BULL trends get broken it is hard to abandon these areas.

Financials

The Financial ETF was on the brink of breaking a solid support level before staging an 8% rally in the last 6 trading days. Similar to “energy” I used the WEEKLY chart to point out to members of my service how close this group is to a total breakdown. Today’s price for the financial ETF (XLF) has come down to the OLD highs achieved before the pandemic. This SHOULD be solid support now. If this range can hold it will erase the potential for the XLF to drift back to November ’20 breakout level which is about 18% lower.

I added “put” option positions on select Fin Tech names this week. In my view, all of these stocks are ripe for a pullback after this recent rally. None are making money and they will get destroyed in a recessionary backdrop.

Homebuilders

Perhaps a ‘signal’ or just a mere coincidence? The Homebuilder ETF has posted a 5-week 21% rally off the intraday low on June 24th. All taking place during some of the worst data reports we’ve seen in the industry in a long time. When bad news is ignored it usually signals a bottom is here or close by and this has been the theme during the last 7 trading days in the major indices.

Healthcare

Healthcare is the other sector that is in an LT BULLISH setup. Perhaps it’s the fact that the sector is made of a mixture of stocks that can be listed as defensive while others possess good growth prospects. They are also considered to have the ability to withstand a recession better than most companies. Many pay above-average dividends. The DAILY chart shows a short-term sideways pattern BUT the Longer term view is back in BULL mode.

Biotech

Despite the 2+% giveback on Friday, The Biotech ETF (XBI) has been a stellar performer (+26%) since the BEAR to BULL trend pattern was identified in June. A pause and consolidation period might be next, but as long as the ETF holds key support, it’s not time to abandon this trend. Of course, it’s always advisable to harvest outsized profits along the way OR sell upside calls to add income as price hits resistance.

Technology

Similar to the general market, The Technology ETF (XLK) has cleared initial resistance and now faces more challenges ahead. The road to recovery is a long one. The best case scene for the BULLS would be for this sector and the major indices to now trace out a sideways pattern that is the start of a bottoming process.

Technology Sub-Sector – Semiconductors

Last week I uncovered a setup for members of my service in the charts of the Semiconductor ETF (SOXX) demonstrating what could also play out as a successful test of longer-term support. The 200-WEEK moving average has been tested, held, and produced a bounce.

So far so good. The semis led the way with a gain of ~6 % this week bringing the rally off the July 5th close to 18%. The downtrend has not been broken in the SOXX ETF, and there is resistance ahead, but it’s a start.

ARK Innovation ETF (ARKK)

I continue to watch ARKK very closely as a proxy for speculative high-growth stocks. As perhaps the best measure of some of the worst companies in the market based on current fundamentals/valuation, it’s a good indicator of risk appetites. Its recent outperformance has been one of the reasons for supporting a general market rally. Like Biotechs (XBI), it has been a huge winner for SAVVY investors. Since uncovering this setup ARKK is up 35%.

International Markets

China

The outperformance of China over the past couple of months has provided evidence that a potential bottom has formed in their markets. Since these were some of the first areas to top out last year, it’s certainly possible they may find a bottom before other markets.

Recent data does show the Chinese economy weakening but that was thanks to Zero-COVID lockdowns. At some point, that too will end. There are limits to how much growth credit stimulus can catalyze, but for the time being President Xi and the rest of the China Communist Party apparatus focusing on stimulating growth is an incremental positive for global economic activity.

I continue to HOLD my positions in select Chinese equities.

Cryptocurrency

Alongside risk assets, cryptos have been rebounding over the past few sessions. Despite those moves higher, the largest cryptos like Bitcoin and Ethereum remain rangebound and trending sideways. Major cryptos have also not rallied enough to completely erase recent losses.

BTC

Bitcoin (www.bespokepremium.com)

As for where that leaves them about their trading ranges, BTC is at the upper end of that range and struggling with resistance. Seasonality is turning into a tailwind; especially so for Bitcoin whose one-week and one-month performance rank in the top 5% of all periods of the year. Not only has this point of the year historically been positive for performance, but volumes also tend to bottom out.

After trading in a tight range recently BTC rallied to the top end of its trading range at 22k.

Final Thought

I’ve consulted with colleagues who have witnessed many market cycles. Spoken with technical analysts, and economists. Consulted stock market “models” and a recent Elliot Wave analysis, and I’m left with the same conclusion.

Everyone and every “model” is filled with uncertainty. Overwhelmed with conflicting results. That represents a scenario that confirms what has been said before. These are unique times, and while a case can be made for a move back up the ladder that gets indices back to neutral and higher, there is another view that says the lows will be tested and they could fail at support.

A passage from a newsletter that I read recently fits today’s investment scene.

President Bill Clinton once remarked,

“There is nothing wrong with America that can’t be fixed by what is right with America”

Ladies and gentlemen; America currently needs “fixing.” Since Mid 2021 I’ve pointed out the policy errors that have led the investment scene to where we are today. The ineptness of Congress adds to the mayhem. This has left the equity markets in a state of confusion and as mentioned before market participants are exhausted. That translates to a stock market that doesn’t know what comes next, what data point gets worse, and how this economy can recover in this setting.

It’s not a great situation, BUT there is a view that suggests much of the future pain that may come to our economy over the next few months has already been priced into stock and bond prices. The market changed direction to the downside before any of these issues were identified as problems. It anticipates change. Therefore it’s a fair assumption that the downside risk has been mostly priced in. Take this week’s poor report on Homebuilder Sentiment as an example. The index has declined for 7 straight months and is at the lowest reading since the lows during the pandemic. Yet, the Homebuilder ETF was flat on a day when the S&P lost about 1%. Later on, we’ll see how this ETF has staged a BIG rally.

That suggests we could be witnessing what could be the lows in all of the economic reports for now.

Maybe there is a bit more downside to go, maybe not. I don’t know for sure because the problems we face today remain a very fluid situation. It is a fair assumption that the stock market has priced in a mild recession that will take earnings down a notch. That is why individual stocks and certain sectors have given back much more than the present 16% drop in the S&P 500.

Everyone is aware of the fundamentals, so what will drive price action will be the “technical” trends in the market. Support and resistance levels will be in charge in the short term. Computer algorithms are geared to respond to these levels. I mentioned that the BULLS will now have to step up and prove that any “turn” will have staying power.

I plan to watch the situation unfold one day, one week at a time while making no assumptions as to what comes next. The story that has already played out this year is FAR from over.

Postscript

Please allow me to take a moment and remind all of the readers of an important issue. I provide investment advice to clients and members of my marketplace service. Each week I strive to provide an investment backdrop that helps investors make their own decisions. In these types of forums, readers bring a host of situations and variables to the table when visiting these articles. Therefore it is impossible to pinpoint what may be right for each situation.

In different circumstances, I can determine each client’s situation/requirements and discuss issues with them when needed. That is impossible with readers of these articles. Therefore I will attempt to help form an opinion without crossing the line into specific advice. Please keep that in mind when forming your investment strategy.

THANKS to all of the readers that contribute to this forum to make these articles a better experience for everyone.

Best of Luck to Everyone!



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