The Week Ahead: Risk Assets Will Suffer Greater Pressure After A Dead Cat Bounce
Pinchas Cohen | Jul 10, 2022 08:45AM ET
- Traders are flip-flopping on theme in a lack of market leadership
- Friday's deepening yield inversion provides a warning sign
- The stock market rally is more likely to fizzle than continue
Last week was great for the stock market. Traders may be lured into the previous week's roaring week and think the worst is behind us and that we're back to rallies. However, I don't think so. Even if stocks rally another week, as far as I'm concerned, this is a bear market rally, as I predicted last week.
Some analysts are puzzling at last week's vociferous rally. The Dow Jones Industrial Average gained 0.8%; the S&P 500 rallied 1.9%. The US Small Cap 2000 added 2.4%, and the Nasdaq 100 surged 4.66%.
Economists are incredulous as to why investors were willing to increase risk amid positive economic developments, because they initially hoped for an economic slowdown that would convince the Fed to ease its aggressive tightening.
However, traders surprised analysts, buying stocks even after the ISM Non-manufacturing Index and the Jolts job openings beat expectations.
What flipped sentiment from hoping for signs of a slowdown and betting on easing interest rates to going bullish despite economic data supporting a continuously hawkish Fed with members? I think it's the technicals.
After the worst first half of a year since 1970, extreme moves tend to correct, and I suspected that such an "accomplishment" would attract bargain hunters. The charts also convinced me that stock indexes were primed for corrective rallies. We often see that whether data and fundamentals prompt investors, they make their moves according to support and resistance.
h2 Equity Index Charts/h2The Russell 2000, which we discussed in depth last week, respected the support found by the trend line tracing the highs of 2018 and 2020. At the same time, the price neared the bottom of a channel. We bet that the small-cap is more likely to bounce off that support. Note that it still has room to climb to the end of the channel, but its chances have been reduced from last week. After all, this is a Falling Channel, meaning sellers have more power. The preceding upward range from May 12 till Jun 13 may be a Rising Flag, bearish after a sharp drop, but those are shorter, roughly 1 through 3 weeks.
Now, let's look at the other US averages.
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The popular index climbed to the downtrend line, meeting with the neckline of a possible H&S top.
The Dow reached the top of its Falling Channel, which converges with horizontal support and resistance between the previous trough and the current peak in the downtrend.
Finally, the tech-heavy Nasdaq 100 is an anomaly among the US benchmarks.
The NDX broke through the top of its falling channel, increasing the likelihood of a further rally. Note, the price still has to overcome the June highs and the 50 DMA, but if it manages to, it will have cleared a path to the next resistances, either the Feb 24 low or the flatter downtrend line. To clarify, it doesn't have to get there. It could very well fall back on fundamentals and macroeconomic data. I'm just addressing the technical aspect. I expect less resistance to enduring bearish resistance on the consideration of price alone.
h2 Explaining the Moves/h2Back to the erratic market narrative I discussed above. Investors hoped economic data would show that growth is slowing, allowing the Fed to ease its heavy foot on the accelerator. Yet, investors turned bullish despite positive reports. The Nasdaq climbed for every day of the week in its longest winning run since Nov.
Still, Friday showed a mixed day on Wall Street, with all but the powerful Nasdaq slipping, even that tech-heavy gauge eked out only a 0.1% gain. Why? Friday's strong jobs report reaffirmed economic strength, refueling bets the Fed will stay aggressive. Governor Christopher Waller and James Bullard, two of the Federal Reserve's most hawkish members, are backing another 75 basis point hike.
However, what caught my eye was the multilayered contradiction in markets. First, the market narrative dictates that traders are hoping for weak data to reduce pressure on Fed tightening. Economic data throughout the week was positive, and traders still increased risk. That's one contradiction. Then, Friday's job report resumes the same theme of better than expected data, but now traders remembered how they set out to view the market reaction to economic data at the beginning of the week? If traders were bullish on data throughout the week, what changed on Friday?
Perhaps, psychology. After the worst first half of a year in over 50 years, dip buyers seek bargains, helping drive prices up at the beginning of the week. Sure enough, the NDX surged almost 3% on Tuesday, the lion's share of the weekly move on the first trading day of the holiday week. Also, staying locked into a position for a weekend is riskier. So, traders cash out. Finally, the gauges returned to resistance after starting at support levels. Remember, bear markets also have rallies. They are some of the strongest ones. We've just seen one. I expect it to weaken this week, even if it does endure.
And why do I know investors treated the jobs report differently than the rest of the week's positive data? Treasury yields. I noticed that the 10-year and 2-year yield inversion deepened. The two-year note went up 13 basis points, while the 10-year note climbed only nine basis points.
You can see in the chart how the gap widened.
In a functioning economy, longer-term bonds pay out better than shorter-term bonds. When that relationship inverts - and investors are driving that inversion, as they are willing to commit to long-term bonds, even though its yields are falling, because they think it's the lesser of evils - it is a leading indicator of a recession.
h2 Currencies And Commodities/h2The US Dollar Index Futures may dip this week before continuing higher.
The dollar fell after Friday's job reports, which is noteworthy. If a more robust jobs report pushes the Fed to keep the pressure on rising interest rates to quell the inflation that will be further boosted by more people working, the dollar should be more substantial. Furthermore, if stocks fall because of the Fed's tightening, the dollar should strengthen as a haven. However, the humans who are doing the trading are also impacting scientific thinking.
After the Greenback completes a bullish pennant within a bullish triangle, some investors may want to lock in profits. Furthermore, the initial spike after the breakout will likely result in a short squeeze. Now that that is over, the suddenly reduced demand created by short-covering and the longs cashed out leaves a vacuum in demand, allowing the price to fall. The closer the return to 105, the better the buying opportunity.
Gold Futures rose slightly, for the second day, amid dollar weakness. And, again, technicals.
After a two-day drop, gold found support near the bottom of its channel. However, I think that technically it's too late for gold at this juncture. The pressure is down after falling below its uptrend line since the Mar 2021 low, and even if gold rallies toward 1,800, it will turn around and increase its selloff.
Bitcoin is primed to resume its long-term downtrend after giving traders false hopes in the form of a weekly rally.
The cryptocurrency is trading along a pennant after completing a symmetrical triangle on the hourly chart, which, if I'm right, will fit in with my overall bearish position.
Here is the daily chart to understand how bearishness fits the hourly chart.
Bitcoin has found resistance after completing a return move to a bearish pennant. See also this article.
Oil had a tumultuous week. It dropped in the double digits on Monday as the recession trumped a tight market. Yet, in the last two days of the week, the falling supplies returned to the forefront of traders' minds amid positive economic data. From a technical standpoint, I consider this a return move before another leg down.
Oil found support by the bottom of a larger symmetrical triangle, helping the price bounce in a return move to a rising flag, bearish after the preceding drop. Note that the increasing flag helped bears push the price below its uptrend line.
The $108 area will provide an attractive shorting opportunity. If the price returns below $96, I expect the price to fall toward $60, which jives with an expectation of a recession, as well as the technicals
Happy trading!
Disclosure: I have no positions in instruments discussed.
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