Each week we do a technical analysis of the major markets for subscribers to Margin of Safety Investing. We use a combination of quantitative and technical measures with Elliott Wave and Harmonics overlays. Here is an annotated version of it that might be useful as you navigate the market’s volatility.
In short, we believe that the U.S. large caps are on thin ice. Small caps, represented by the iShares Russell 2000 (NYSEARCA:IWM) have been under pressure for a year now. In past bear markets, large caps have been the last to “give up the ghost.”
The wild card has been quantitative easing. That is going away imminently. The Fed is also going to move toward real interest rates that are not negative this year. Whether they get there or not is another story. Regardless, there will be pressure on stocks, especially of capital intensive companies, that come under pressure in coming months.
Large Cap Technical Analysis
The following is our technical view of markets. Scott Henderson uses proprietary technical analysis including Elliot Wave and Harmonics. I use more quantitative factors based on volume weighted trading. We are including our longer-term views, i.e. weekly and monthly charts.
S&P 500 (SPY)
Shooter says Risk Off! I clearly have multiple bearish counts from $420-380. I don’t know if I believe it’s that deep here because I’ve been faked out so many times now. But technically it’s staring me right in the face.
My S&P 500 target remains quite a bit lower for later this year based on where institutional (pensions, hedge funds, family offices, etc…) buying support resides. I would be mildly surprised if the S&P 500 doesn’t make a run to the January 2020 price levels or slightly lower. Jeremy Grantham recently gave another interview to Bloomberg in which he suggested about 250 on SPY represented a target price to pop the QE driven stock market bubble. He also mentioned real estate as in a dangerous place.
While I do not own SPY, I do recommend that anyone owning it, sell it now. If you want to maintain equity exposure, add better ETFs, a basket of stocks or both. Sell SPY though, it is possibly in the highest risk spot in history.
Nasdaq 100 (QQQ)
Shooter says Risk Off! Measures to $316. I’m more inclined to believe this count than the SPY with how the Nasdaq has been acting. We need a flush so buyers feel comfortable to step in.
I still massively prefer QQQ to SPY for the rest of this decade. Over time 100-200 Zombie companies on SPY will be replaced and it might be a different story then. There is significant support for QQQ around $300, however, much more solid support develops below $250. We will need to monitor downward momentum in real time when it happens to know which support level holds.
I would be surprised if we see the Armageddon Zombie Apocalypse, but we never know. If fear causes “passive” indexers to panic sell, then we could see it. If we do, it’ll be the buying opportunity of a lifetime going into the massive Millennial driven bull market of the next 10-15 years.
Small Caps (IWM)
Shooter says Chop! Use the breakout or breakdown lines on the 90 Min. This should be second to recover after the Dow. It held up much better than S&P and Nasdaq.
I don’t buy small cap indexes as I prefer to use specialty ETFs and pick my own small cap potential 10-bagger stocks. However, the charts above tell us that small cap industries and stocks we like can be bought on the dips.
20-year U.S. Treasury (TLT)
Shooter says Mixed! Short-term we could bounce. I tend to agree with RSI. But, I hope it does so I can reload the shorts again.
My view of 20-year Treasuries is shaped by two things.
First is the “slow growth forever global economy:
Second is that inflation is transitory and will fall dramatically in the next 3-5 quarters.
Interest rates are certainly going to go up more soon as the Fed raises rates. However, long rates are tied to long-term growth and inflation expectations. There isn’t much smart money that expects very high growth or inflation the next 20 years, at least not globally.
The conundrum is how much growth do the Millennials actually drive the next 10-15 years as they go through peak spending and into peak earning. I think there will be a “great divergence” between winners and losers like we have never seen before. That’s why I don’t like SPY. Too many zombies.
I think at least intermediate term, until we see what growth the Millennials drive, there is a ceiling somewhere around 3% on 20-year UST. So, with long rates rising a bit, I don’t want exposure to TLT. And uncertainty keeps me from shorting it. When that ceiling is hit though, TLT becomes attractive to me because I think the economy slows a bit by Q1 next year without a good Build Back Better program.
As I’ve been saying, the large caps are most vulnerable right now. You see that with the “risk off” ratings for SPY and QQQ. I’ll want QQQ sometime this year, but it’s not until at least one more leg down and probably two. I’ll scale in as usual, but I’ll save powder until I see what’s going on around Q3.
The small caps have been correcting for a year now, that’s why the chop expectation. We are in “buy the dips” period the rest of this year on small caps.
Also, keep this in mind, the Fed is going to raise rates 4 or 5 times this year. That will put pressure on the Repo market which they have a trillion dollar “emergency fund” waiting to support. Maybe just having the fund there prevents Repo problems, we’ll see. But, if there are problems and that money finds its way into Repos then it’ll also trickle into equity markets at some point, just like autumn 2019.
Here’s a very good article on the Repo market from Bankrate:
So, whenever the bear market waves down on large caps finish, we will want to become very aggressive buyers across the board. I think that happens by year-end.
One terrible wild card is a more deadly Covid wave in autumn. The way that virus works is to alternate between easier to spread and more deadly. There is a more deadly wave coming, we can only hope it doesn’t spread well.
Given one-third of American’s unwillingness to get vaccinated and generally not wear masks unless required, I am not optimistic about Covid being mostly gone this year. I think we have at least another year and probably 2 or 3 of Covid waves of varying transmissibility and deadliness. That means a really tough year. I do hope I’m wrong.