The Week On Wall Street – A « Reversal » Of Fortune (NYSEARCA:SPY)

« Patience is not just about waiting for something … it’s about how you wait, or your attitude while waiting. » – Joyce Meyer

February is just about in the books and the Bulls can’t wait for the first two months of 2022 to end. Many are forecasting the second half of ’22 will be better with their notion that all of these negative headlines that are driving the market today will be in the rearview mirror. Given all of the crosscurrents this equity market faces, I’m not going to predict what the back half of ’22 will look like.

The reasons are simple. My current strategy is not on the same page as the average analyst or investor. Far too much attention is being paid to the headlines and not enough attention is devoted to what is really going on with all of this market volatility. I introduced the phrase « re-rating » to readers of these articles a few weeks ago.

Before the geopolitical events taking place today, the last time Russia invaded Ukraine was in 2014. During that year, the S&P suffered a peak to trough decline in October of about 9.5%. What is so interesting about that period is the Russia/Ukraine conflict wasn’t even mentioned during the decline.

In 2014, the 10-year Treasury was 2.5%, the price of oil before the conflict was $108, and inflation was running at 1.6%. Today the 10 year is 1.9%, the price of WTI is at $92, inflation is hovering around 7+%.

The S&P 500 has been volatile and at the lows, the index was down 6% in February and 111% off the old highs as the market turmoil is being blamed on the Russian/Ukraine headlines. However, the more I look at this stock market, I’m not buying the « convenient » reasoning that ascribes this market angst to the geopolitical scene. The difference between 2014, when the stock market didn’t blink due to the Russian aggression, and today is staring us in the face – INFLATION. Sure the algos are more dominant now and they rule the « hourly » trading but what is occurring is the result of what I’ve been discussing in great detail during my weekly MACRO updates to members of my service.

What is being lost in all of the « Russian headlines »: the equity market is being re-rated. Investors realize they are leaving a backdrop of low rates and low inflation and entering a period of higher rates and higher inflation. THAT is why the market remains in turmoil. The geopolitical tensions just add to the anxiety that is already present. Investor angst is in place due to this HUGE change to what I’m describing as a NEW ERA that market participants are trying to cope with. Analysts and investors that are glued to the headlines and ignoring the changing backdrop are going to be left behind.

At some point, the geopolitical news moves back into the shadows BUT the Fed isn’t going anywhere, so stocks will still have to contend with rate hikes that are on the table to fight inflation. On that score, I believe the market has the first stages of rate increases already priced in. Now it depends if inflation pressures start to wane. That will determine just how many rate increases we see in ’22, and how far the Fed will have to go. Higher interest rates aren’t helpful for stock prices, but the impact is different depending on the level of prices. We’ve already seen significant pullbacks in the major averages and even larger declines in individual stocks. The sentiment is at some of the most depressed levels we have seen in years.

The market may be reaching a point where a little good news could go a long way and perhaps that started this end-of-week rally. This « re-thinking » of the investing scene is a long-drawn-out process that will have moments of FEAR and perhaps some GREED is thrown in again.

The Week On Wall Street

The indices entered the shortened trading week on a two-week losing skein and sentiment remained sour until the reversal of fortunes on Thursday.

Up until then, the indices spent most of the time in the red with brief attempts at rallies that didn’t have much in the way of staying power. After the dust cleared on Wednesday, the S&P made it four straight days of losses that pushed the index into official correction territory.

A gap-down opening on Thursday sent the S&P 500 to levels that were very close to three standard deviations below its 50-day moving average (oversold extremes). Anytime the market gets too extended in one direction or the other, a sharp and violent snap-back move back to more neutral levels usually occurs.

In a reversal of fortune, the indices erased all of their morning losses on Thursday and sent the indices to strong gains at the close. The S&P reversal amounted to an intraday move of 6.8%. As stocks continued to rally on Friday, all of the indices except for the DJIA posted gains for the week. The S&P 500 dropped 5.2% from the close on Friday, February 18th to the Thursday intraday low (less than 3 trading days). From those same lows on Thursday to the close on Friday the S&P rallied 6.2% in less than 2 trading days.

It’s best not to get too LOW during the selling events, nor too HIGH during the rallies. This volatility will be part of the scene for a while.

The Economy

U.S. consumer confidence index fell to a firmer than expected 5-month low of 110.5 from 111.1 in January., versus a 16-month high of 128.9 in June. This consumer confidence drop joins a Michigan sentiment drop to a 10-year low of 61.7 from a prior low in January and an IBD/TIPP index drop to a level just a tick above a 6-year low in November.

Bottom Line; All the measures have deteriorated sharply from peaks around mid-2021.

Housing

New home sales declined 4.5% in January to an 801k pace, slightly below estimates. However, let’s not forget sales jumped 12.0% to 839k in December and bounced 12.3% to 749k in November.

Pending home sales dropped another 5.7% to 109.5 in January after falling 2.3% to 116.1 in December. It is the lowest since April. A lack of inventory has been a major factor in recent weakness, along with rising mortgage rates and affordability issues.

Manufacturing

The IHS Markit Flash US Manufacturing Purchasing Managers’ Index rose from 55.5 in January to 57.5 in February, signaling a stronger improvement in business conditions across the sector. Although the Suppliers’ Delivery Times Index continued to inflate the PMI, the latest reading was also boosted by stronger increases in output and new orders.

Richmond Fed manufacturing index dropped 7 points to 1 in February, below forecast, after falling 8 points to 8 in January. This is the lowest since September. It was at 15 last February and has bounced between -3 and 27 since June 2020.

The Kansas City Fed’s February reading on manufacturing activity was expected to grow at an accelerated rate with forecasts calling for the headline number to rise from 24 to 25. Instead, the actual reading came in even higher at 29. That is the strongest reading on the region’s manufacturing economy since last May.

The Global Scene

Markit Research released February flash PMIs for a range of global economies. Manufacturing PMIs have broadly started to stabilize, while Services PMIs have had a volatile showing with some big rebounds and some serious drops.

Bottom line: PMI readings are at or above pre-pandemic levels and are not indicating any « stress ».

Global Markets

Looking across the US-listed ETFs that track the various country stock markets, it should come as no surprise as to which country currently finds itself at the bottom of this list, and it isn’t even close: Russia (RSX). RSX is now down 42% from its 52-week high set last October and is down 27.5% year to date. That leaves the ETF over three standard deviations below its 50-Day moving average, but only one week ago, it was actually above that same level.

As for the rest of the countries tracked, half are oversold with multiple others including Germany (NYSEARCA:EWG) and China (NASDAQ:MCHI) over two standard deviations below their 50-DMAs. The United States (NYSEARCA:SPY) ranks as the third-worst country of these with regards to year-to-date performance. Brazil (NYSEARCA:EWZ), South Africa (NYSEARCA:EZA), and Malaysia (NYSEARCA:EWM) are overbought and sitting on some of the largest (and only) year-to-date gains.

The BRIC countries find themselves on opposite ends of the spectrum of performance. While RSX and MCHI are at or close to 52-week lows, and India (BATS:INDA) is near multi-month support, Brazil is sitting on a sizable 20% YTD gain. That being said, it also remains nearly 20% below its 52-week high set last spring even after the massive rally this year.

Geopolitical Scene

I see little reason to go into any details on the Russian/Ukraine situation. I am not an expert on the geopolitical scene. More importantly, I believe I have made my feelings known regarding what is troubling the equity market here in the U.S.

Every long-term analysis of this situation discloses the same conclusion. While the pain and suffering caused by this conflict are real and should not be minimized, this event is a mere blip on an investor’s radar screen.

Food For Thought

Despite higher energy costs amid inflation levels at 40 years highs, it’s apparent the « agenda » remains in place.

Biden Administration Halts New Oil And Gas Drilling Permits »

The « social cost of carbon » apparently takes precedence over everything else as the U.S. has adopted a climate policy in lieu of an energy policy.

The ramifications of the ‘agenda » are just now making an impact and it’s apparent the messaging on this topic isn’t about to change anytime soon. The European Union has already taken this path. Because the « green » components of their strategy are not ready to meet their needs they find themselves at the mercy of Russia as their energy source. Russia invades Ukraine and the European Union steps up its purchase of Russian Gas and Oil. They simply have no choice given the lack of U.S. energy policy.

Many months ago I warned that the biggest threat to the economy and the stock market was « policy errors ». The incoherent energy policy in what is a « green or nothing » agenda has destroyed U.S. oil independence. Ramifications are now showing up in the economy in the form of inflation. Higher oil prices are fueling the Russian aggression against Ukraine. It’s added untold profits to the Russian « cause ».

There doesn’t appear to be any end to what has been this parody on the Keystone Cops. Based on the current mindset and resulting energy policies, there are no solutions on the horizon that would suggest crude oil prices will be coming down anytime soon.

Despite the massive gains, staying invested in the entire energy complex remains a sold strategy for ’22.

What may eventually lower the price of crude oil is a recession.

Sentiment

Once again this week, less than a quarter of respondents to the weekly AAII sentiment survey reported as bullish. Although it was an improvement from 19.2% last week, the current reading of 23.4% remains at low levels. Also, note, this data was collected BEFORE today’s events.

More importantly, Bearish sentiment crossed above 50% as recently as the last week of January, and after falling back down to 35.5% earlier this month, it is now back above 50%. Bearish sentiment surpassed the January high of 52.9% by 0.8 percentage points this week to reach the highest level since April 2013 at 53.7%.

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

I don’t call market tops and I never attempt to call market bottoms. Instead, I’ll use the short-term data in front of me to make short-term trading decisions. This week presented an opportunity in the short term. Whether the rebound rally can be sustained is another story.

The S&P broke below the January lows and with the two-day rally, some technicians are calling this pattern a typical « undercut low » where price briefly drops below a former low then quickly rebounds.

All of the technical damage that was done during the selling event will have to be repaired now. There is plenty of overhead resistance for the BULLS to overcome in the near term. Selling pressure will come from those that are « trapped » at higher prices and view the rally as an opportunity to get out. That sets up a battle of wills between the BULLS and the BEARS in the days/weeks ahead.

Investment Backdrop

A One-Sector Bull Market

The S&P 500 is down 10%, but to a lot of investors, the decline has been even more painful because bonds, which usually provide support in times like this, have declined just as much as equities. This week the S&P briefly entered correction territory, joining the NASDAQ and the Russell 2000. That leaves the DJIA standing at 9.7% off its former high as the only index that has not joined the « correction club ».

Besides Energy this year, nothing has worked for investors. A company can have all the growth in the world, but if the earnings aren’t there good luck. Bonds, which usually provide some level of support during a market sell-off, have done just as bad as equities.

Energy is up 20% and there is a 34% gap between Energy and technology performance.

Given the strong selloff this week, many important technical levels in just about every sector were breached. That was followed by a strong rebound rally. So for this week’s analysis, there is little reason to delve into details until the situation can be analyzed thoroughly.

All of this technical damage will have to be repaired before anyone declares an « all-clear ». Fundamentals are of little importance now as the short-term story will be about the technical patterns that are presented in the following days/weeks. What happens on that front will determine whether this pullback will remain just a correction or turn into a full-fledged bear market.

My strategy dictates that this now becomes a period to be VERY observant. With so many stocks having already suffered through their corrective periods I am on the hunt for names that have not broken below their January lows despite this new period of weakness. Another important factor will be whether or not the stock remains in a BULLISH long-term configuration. The deep correction that hit many stocks has caused price action that violated their long-term trendlines. For the moment those names are off my radar screens.

The 2022 Playbook Is Open For Business

Thank you for reading this analysis. If you enjoyed this article so far, this next section provides a quick preview of what members of my marketplace service receive in DAILY updates.

Small Caps

By conventional standards (-20%) The Russell 2000 (IWM) has dipped into « BEAR market » territory. Using my BULL/BEAR strategy model, I’ll be watching where the index closes at the end of February, to determine IF the cautionary signal remains in place for the index.

Sectors

The Communications sector (XLC), has issued a BEAR market warning. However, the price action is so volatile there is no reason to jump to conclusions. All of the other sectors remain in a BULLISH configuration.

Energy

It has become a ONE sector BULL market and the energy group is that stand-out sector. With the energy policies that are in place, there was never much doubt that the price of oil was headed higher. The message here has been consistent and the overweight positioning is paying off handsomely. It’s not just the fundamental picture that was so interesting, the technical patterns displayed in early ’21 signaled the start of a new Energy BULL market. The uptrends in the energy ETF (XLE) and the Energy exploration ETF (XOP) remain solid.

With the invasion « news » no longer a mystery, the energy trade reversed on Thursday. At some point, the « war premium » will probably be reduced and stocks may now finally see the pause I was looking for. This trade isn’t over as the backdrop for prices to remain at or around these levels remains in place.

Another sub-sector that I’ve been involved with since early ’21 has been the Refiners. Overall, earnings results have been better than expected as counter-seasonally strong margins and still-recovering demand push refining earnings to mid-cycle or higher levels. In addition to the price gains, many stocks in this group also pay handsome dividends.

Valero Energy (VLO) is a Savvy selection that has rallied 17% this year and despite that gain, the stock yields 4.5%.

Gold

The SPDR Gold Trust ETF (GLD) broke to the upside this week but ran right into an overhead resistance level and reversed sharply. I do wonder IF the recent strength we have seen in this trade will continue to reverse. The news on the invasion is no longer a catalyst, and as I have mentioned in the past if GOLD can’t sustain a breakout rally in this backdrop, I question when it will be able to. Not enough evidence to get me interested in this trade at the moment.

Cryptocurrency

The equity market settled into a risk-off mentality and traded down below the January lows. The two proxies I use to measure the crypto market are Grayscale Bitcoin Trust (OTC:GBTC) and the Bitcoin Strategy ETF (BITO). Both followed the same risk-off pattern as they are in the process of nearing their January lows as well.

Anyone selling the notion that Bitcoin was an inflation hedge is hard-pressed to defend that position now. The same goes for the group that pounded the table telling everyone what a great store of value crypto is. After watching the trading patterns in this asset it is neither, and I’ll add it is not a hedge against anything.

Why don’t we just call it what it is? A speculative tradeable asset that I am currently trading.

Final Thought

A different investment landscape requires a different strategy. It’s deja vu all over again as there is a distinct crisis of confidence everywhere I look. Don’t take it from me, look at the consumer confidence surveys. This negative mindset has spilled over to the financial markets. Multiple polls and surveys indicate how dissatisfied the general public is with the policies, actions, or lack of action on just about every topic that has made headlines recently. Once again don’t take that from me. The results are all there and readily available from a bevy of sources.

This lack of confidence exacerbated by the inflationary scene today is the root cause of what is ailing the stock market. At some point, it may bleed over to the entire economy. The low inflation, low-interest rate scene is a thing of the past, as all of the policy errors have finally made their impact known. Unless you have been on a deserted island for a year or have been living in denial of the facts, none of this should come as a surprise.

The equity market responds to « change » and make no mistake, the time has come for a « reset ». The « Old » strategy used for the better part of this BULL market isn’t going to work. Those that are « open-minded » and « flexible » will have a better chance of surviving this reset than those that have their heads buried in the sand.

Our prayers and thoughts should be focused on the plight of the Ukrainian people who are under unimaginable stress. »

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!