The Correction Deepens
When and at What Level Can a New Rally Begin?
The stock market is facing geopolitical tension in the Middle East, as well as macro concerns about sticky inflation. On top of that earnings season is heating up and companies that disappoint in revenue, earnings, or outlook could fall drastically, as P/E ratios and valuations appear priced to perfection.
The Intermarket picture is not currently supportive of a stock market rally as rising interest rates (TNX) and the US Dollar (DXY) combine to form a double whammy for stocks and bonds. You can see in the chart below that both TNX and DXY are trending higher above their respective 21 Exponential Moving Averages (EMA or blue line). Rising interest rates tend to deflate P/E Ratios and typically hit growth stocks especially hard. A rising US Dollar shows evidence of a flight to safety, where investors sell risk assets (stocks and bonds) and raise cash. On the bright side, Oil appears to be pulling back, which could help put a damper on future inflation.
Market Conditions
The S&P 500 (SPY) continues to trend lower below a down-sloping 10 EMA (pink line) and 21 EMA (blue line). The way it sliced below the 50 SMA without any support shows us that market participants are in a rush to take profits/reduce equity exposure. We always say — when the SPY is above the 10 and 21 EMAs the market allows you to make money, but when it is below the moving averages it will try to take your money! This is a cardinal rule in my trading and it has kept me out of trouble during this pullback. The chart below tells us a few key items:
Liquidity (black line on the chart) is exiting the market,
Net New Lows tell us it is not a Swing Trader’s Market and stock-pickers could now suffer oversized losses even in their favorite stocks,
The McClellan Oscillator is showing that there is some bottom-picking buying going on and a bounce is possible soon,
The VIX (volatility) is on an uptrend and could continue higher to the 21 level where it runs into prior resistance,
The Advance/Decline Line and Advance/Decline Volume Line are both picking up and confirming that there is some buying occurring.
Although a bounce is possible soon, the McClellan Summation Index, a longer-term indicator of breadth, is on a downtrend and is yet to show signs of turning around.
Rotation - Money has to go somewhere and last week it rotated into Utilities, Consumer Defensives, and Financials. Money is flowing into risk-off sectors and out of risk-on sectors, telling us that this downtrend in the market could continue. Technology’s 7.2% drop last week is a testament to the current risk-off mindset for the market.
Investors appear to be cashing out on the leaders of this past Artificial Intelligence driven rally (SMCI, NVDA) and buying attractive non-technology blue chip stocks such as United Airlines and American Express. When a new uptrend begins, the new rally may have a different set of leaders. We’ll keep an eye on this.
Sentiment - The Fear and Greed Model shows how we stayed in Extreme Greed during most of the rally, however, it took less than one month for sentiment to fall into Fear. A few weeks or months may be needed for sentiment to turn around.
Dumb money is “throwing the baby out with the bathwater”, however, Smart Money is putting capital to work at depressed levels and probably buying non-tech blue chip stocks and defensives. Remember that Smart Money is managing other people's money so while they are systematically employing capital they do not necessarily suffer the pain of potential losses.
The Put/Call Ratio shows that the options market is in the process of washing out call options (bets that the market goes up), as put options (bets that the market goes down) are increasing. Put buying is not at extreme levels yet and has room to run. As put option buying increases, the market could continue lower.
Where Could the Correction End?
We believe that $480 (9% correction), $466 (11% correction) or $460 (12% correction) are key levels where the pullback could find support and end in the short term. That also implies that a new uptrend could begin. $480 is a confluence level where the 125-day SMA (purple line), 38% Fibonacci Retracement level, and the January 2022 high converge. The $466 level is a confluence zone where the 200 Simple Moving Average (red line) and 50% Fibonacci Retracement sit. $460 is the July 2023 high. These are all high-probability reversal levels. The 100 SMA (blue line) at $492 is a low probability reversal area. A bounce could occur from here before another leg down begins. As confirmation that the buyers are back in control, the Anchored Volume Weighted Average Price from the March high (orange line) should be broken to the upside. There is one more key level…
The $474 level is the Volume Profile Point of Control (POC). In other words, from the beginning of the rally starting in October 2023, it is the level where most shares were traded. This POC is often a highly defended level, where bounces often occur. A drop to $474 would equate to a 10% correction.
There is a high chance that a more drastic drop will occur this year because of the 4-Year Cycle. Moreover, another bear market is possible in the latter part of the 2020s due to the 18-Year Cycle. For our paid subscribers, in the Premium Section, we’ll cover these cycles, which we believe are the keys to earning high returns and sidestepping massive drawdowns.
If you have been following us for a while, this week’s Premium Section is a true Cycles Edge that can be used for the rest of your life. I urge you to become a paid subscriber. If you are interested in cycles, you don’t want to miss this.
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Disclaimer - All materials, information, and ideas from Cycles Edge are for educational purposes only and should not be considered Financial Advice. This blog may document actions done by the owners/writers of this blog, thus it should be assumed that positions are likely taken. If this is an issue, please discontinue reading. Cycles Edge takes no responsibility for possible losses, as markets can be volatile and unpredictable, leading to constantly changing opinions or forecasts.