Stock markets in the era of high inflation part 2
Updated
In my previous analysis I went deep into a lot of the fundamentals of what is going in stock markets in the current environment. At the moment the main theme is that the Fed will keep on hiking until the market crashes or something else breaks in the financial system. It is unknown how much time will it take for something to break, but it is probably going to happen in 2022. The current inflationary pressures seem extremely strong as they mostly have to do with issues on the supply side, however the Fed can only affect the demand side and they are determined to crush it. At least that’s their goal and it is unknown whether they will be able to do so. The problem is that inflation regardless of high or low interest rates, does a lot of damage on a lot of companies, as it affects both the consumers and the expenses a company has. Therefore, a lot of stocks started coming under significant pressure many months ago, something that wasn’t really visible when someone was looking at an index.
The major US indices looked fairly strong up until recently, however by looking at ARKK it is clear that many of the more speculative stuff that don’t make money right now started going down since Feb 2021. That was exactly the point where inflation started going up. As inflation was going higher and higher, more and more companies/indices started peaking in 2021. Some in April-May 2021, others in September 2021 and others in November 2021, while many are now down more than 40-50%. For example, Meta (Facebook) is down 50%, and its current situation looks similar to late 2018 (major gap down and then continued lower), but worse. Another example is Netflix which is down 70% and looks like it could go a lot lower.
What is interesting is how Tesla had a huge move up in October – early November, a move that was incredibly abnormal and all indicators were flashing extremely overbought conditions, and Elon Musk managed to sell right at the top while making his move public. This was pretty similar to when Charlie Lee, the founder of Litecoin, made public the fact that he was going to sell his Litecoin position, and his selling marked the top for Litecoin, which occurred a few weeks before the crypto market topped in 2018. What is even more interesting is how Tesla has done so well when many other tech companies have done so poorly, something that could be explained by the fact that finally Tesla is becoming more and more profitable, and on the 20th it announced its earnings which had a big positive surprise. However now these earnings could mark the top for the stock, as its chart is starting to look like a proper top. First an extraordinary blow off top, then failure to push higher or even fill the gap at the top. Then filled the gap at the top while also forming an SFP, and then fell a lot lower. Since then, the market recovered and several exhaustion gaps have occurred up until now, with the most important one being the one that occurred post earnings. When the market opened the day after the announcement, it immediately filled a little gap higher and got quickly slammed back down. These are not good signs for a bull market.
Now I’d like to get into the 4 major US indices, with the S&P500 being the main focus. Here I will go deep into the TA in order to get a better idea of where we are and what is going on. The first one is an uncommon one, but one I really like, and that is the Russell 3000 (top 3000 US stocks). Both the topping and the bottoming processes were pretty clean, as at first the top occurred with a nice distribution pattern after the market had been slowing down. Then the bottom came after a 15% correction from its ATHs, and as the market retested its Feb-March 2021 highs which turned into support and right after it swept the May lows. Initially there was strong bounce, then retested the May lows which held and then it pushed higher. However once the market retested the September highs and swept the Feb 2022 highs, it got badly rejected and yesterday it had an awful close. So far this chart could have been the perfect guide for someone trading the US stock market, however it isn’t enough from now on.
The next one we are going to look at is the Russell 2000, which had an insane rally in 2020 and early 2021, but since March of 2021 it entered a huge distribution phase. In September the distribution phase was confirmed as the market had a huge breakout that quickly failed and the index quickly retested its range lows. When the range lows broke, they then turned into resistance and have rejected the market twice. Currently the market is retesting the lows once again, which makes me think that they will be broken after being tested so many times. This area could be seen as a double/triple bottom that hasn’t been swept and therefore it is acting like a magnet. In my opinion the market will break the lows, and at best it will have a little bounce after sweeping them, as this pattern looks extremely bearish. After a year of distribution and multiple confirmations of it, it is pretty hard for the market to bottom quickly and therefore after breaking the lows it could collapse further. It looks like the minimum target from here is the 2018 ATH, while fully reversing the vaccine/election trade is pretty likely and means that the Russell could get to 1700 this year.
The third index we’ll look into is the Nasdaq 100, and we will look at the spot ETF, not the futures. The reason why I want to look at the spot ETF and not the futures, is that the ETF has some major areas which are of interest, that don’t exist on the futures. In terms of the topping and the bottoming processes, there isn’t much to be said here that differs from what was said above or the futures, other than the fact Nasdaq had two major gaps down that haven’t been filled. This is clearly an indication that tech is being sold a lot harder than the rest of the stock market and that in the future these areas could act as resistance. Now the key area I am looking at, is the triple bottom in the first green zone which like the Russell 2000 bottom will probably be broken even it’s just to sweep the lows and then move higher. The second area is the second green zone which was major resistance in the past and has turned into support, and the third one is that major gap at 276 which could be filled.
Another similar chart is that of the S&P500 spot ETF, which has two double bottoms waiting to be broken, and one of the double bottoms is right above a major gap. Like with all the areas mentioned above, these could simply be local bottoms and the market might just have weak bounces or no bounces there. However, I expect the test of 390-400 on the SPY to give a major bounce as it looks a lot like when the Russell 3000 retested its Feb-Mar 2021 highs, swept the lows and filled the gap.
Before I zoom out to get better perspective of what is going on the SPX, I’d like to zoom in on the SPY and see how important these gaps and double tops/bottoms are. For example, the two most recent local tops occurred with a gap and by filling a gap, with the first one also sweeping a triple top. The major bottom at 410 occurred after filling a double gap (two unfilled gaps in the same area) and the second bottom around 415 occurred with an SFP. Therefore, you can see how important these patterns are.
By zooming out again and using the major Moving Averages, we can see that they are giving us clear signals of whether the market is in an uptrend or downtrend, as well as clear signals of where major support or resistance levels lie. For example, the market bottomed at the 400 DMA, and recently topped at an area where the 100 & 200 DMAs were about to cross. Usually when a major MA is tested so many times, it eventually breaks (400 DMA about to be broken). So at the moment the market is in downtrend which might accelerate below the 400 DMA, which looks like it will get broken fairly soon. Then until it gets reclaimed, I assume the trend is bearish and we need to be cautious.
By zooming out even more, the two other major MAs I am paying attention to are the 200 and 400 WMAs. At the moment, getting to the 400 WMA seems a bit far-fetched as by that time the Fed will have probably stepped in to save the day.
Many are comparing the current hiking cycle with that of 2018, as the Fed kept raising rates until the market collapse and then it quickly stopped hiking rates, and in my opinion this is a decent comparison. Clearly not a perfect one as inflation is much higher, the Fed Funds Rate much lower, the Fed is about to start hiking by 0.5%, markets are more elevated and the global economy in a worse position than back then. The reason why I think this is a decent one and I want to compare it to 2018, is because I think the Fed is in a similar or probably worse position that back then, and therefore they will have to reverse course. Back then the market bottomed after a 20% from its ATHs and at the 200 WMA, which is currently 28% below the ATHs. On the chart below you can see what these corrections would look like when zooming out. I’ve also added what it would look like if we had a mega crash and the market retested the 2000-2008 highs, something I think is extremely unlikely at the moment. As our fiat system is crumbling, the Fed and the US government will be forced to print a lot of money, and therefore the stock market will keep going higher and higher, regardless of how bad the financial conditions are and how many deep corrections will it have.
The major US indices looked fairly strong up until recently, however by looking at ARKK it is clear that many of the more speculative stuff that don’t make money right now started going down since Feb 2021. That was exactly the point where inflation started going up. As inflation was going higher and higher, more and more companies/indices started peaking in 2021. Some in April-May 2021, others in September 2021 and others in November 2021, while many are now down more than 40-50%. For example, Meta (Facebook) is down 50%, and its current situation looks similar to late 2018 (major gap down and then continued lower), but worse. Another example is Netflix which is down 70% and looks like it could go a lot lower.
What is interesting is how Tesla had a huge move up in October – early November, a move that was incredibly abnormal and all indicators were flashing extremely overbought conditions, and Elon Musk managed to sell right at the top while making his move public. This was pretty similar to when Charlie Lee, the founder of Litecoin, made public the fact that he was going to sell his Litecoin position, and his selling marked the top for Litecoin, which occurred a few weeks before the crypto market topped in 2018. What is even more interesting is how Tesla has done so well when many other tech companies have done so poorly, something that could be explained by the fact that finally Tesla is becoming more and more profitable, and on the 20th it announced its earnings which had a big positive surprise. However now these earnings could mark the top for the stock, as its chart is starting to look like a proper top. First an extraordinary blow off top, then failure to push higher or even fill the gap at the top. Then filled the gap at the top while also forming an SFP, and then fell a lot lower. Since then, the market recovered and several exhaustion gaps have occurred up until now, with the most important one being the one that occurred post earnings. When the market opened the day after the announcement, it immediately filled a little gap higher and got quickly slammed back down. These are not good signs for a bull market.
Now I’d like to get into the 4 major US indices, with the S&P500 being the main focus. Here I will go deep into the TA in order to get a better idea of where we are and what is going on. The first one is an uncommon one, but one I really like, and that is the Russell 3000 (top 3000 US stocks). Both the topping and the bottoming processes were pretty clean, as at first the top occurred with a nice distribution pattern after the market had been slowing down. Then the bottom came after a 15% correction from its ATHs, and as the market retested its Feb-March 2021 highs which turned into support and right after it swept the May lows. Initially there was strong bounce, then retested the May lows which held and then it pushed higher. However once the market retested the September highs and swept the Feb 2022 highs, it got badly rejected and yesterday it had an awful close. So far this chart could have been the perfect guide for someone trading the US stock market, however it isn’t enough from now on.
The next one we are going to look at is the Russell 2000, which had an insane rally in 2020 and early 2021, but since March of 2021 it entered a huge distribution phase. In September the distribution phase was confirmed as the market had a huge breakout that quickly failed and the index quickly retested its range lows. When the range lows broke, they then turned into resistance and have rejected the market twice. Currently the market is retesting the lows once again, which makes me think that they will be broken after being tested so many times. This area could be seen as a double/triple bottom that hasn’t been swept and therefore it is acting like a magnet. In my opinion the market will break the lows, and at best it will have a little bounce after sweeping them, as this pattern looks extremely bearish. After a year of distribution and multiple confirmations of it, it is pretty hard for the market to bottom quickly and therefore after breaking the lows it could collapse further. It looks like the minimum target from here is the 2018 ATH, while fully reversing the vaccine/election trade is pretty likely and means that the Russell could get to 1700 this year.
The third index we’ll look into is the Nasdaq 100, and we will look at the spot ETF, not the futures. The reason why I want to look at the spot ETF and not the futures, is that the ETF has some major areas which are of interest, that don’t exist on the futures. In terms of the topping and the bottoming processes, there isn’t much to be said here that differs from what was said above or the futures, other than the fact Nasdaq had two major gaps down that haven’t been filled. This is clearly an indication that tech is being sold a lot harder than the rest of the stock market and that in the future these areas could act as resistance. Now the key area I am looking at, is the triple bottom in the first green zone which like the Russell 2000 bottom will probably be broken even it’s just to sweep the lows and then move higher. The second area is the second green zone which was major resistance in the past and has turned into support, and the third one is that major gap at 276 which could be filled.
Another similar chart is that of the S&P500 spot ETF, which has two double bottoms waiting to be broken, and one of the double bottoms is right above a major gap. Like with all the areas mentioned above, these could simply be local bottoms and the market might just have weak bounces or no bounces there. However, I expect the test of 390-400 on the SPY to give a major bounce as it looks a lot like when the Russell 3000 retested its Feb-Mar 2021 highs, swept the lows and filled the gap.
Before I zoom out to get better perspective of what is going on the SPX, I’d like to zoom in on the SPY and see how important these gaps and double tops/bottoms are. For example, the two most recent local tops occurred with a gap and by filling a gap, with the first one also sweeping a triple top. The major bottom at 410 occurred after filling a double gap (two unfilled gaps in the same area) and the second bottom around 415 occurred with an SFP. Therefore, you can see how important these patterns are.
By zooming out again and using the major Moving Averages, we can see that they are giving us clear signals of whether the market is in an uptrend or downtrend, as well as clear signals of where major support or resistance levels lie. For example, the market bottomed at the 400 DMA, and recently topped at an area where the 100 & 200 DMAs were about to cross. Usually when a major MA is tested so many times, it eventually breaks (400 DMA about to be broken). So at the moment the market is in downtrend which might accelerate below the 400 DMA, which looks like it will get broken fairly soon. Then until it gets reclaimed, I assume the trend is bearish and we need to be cautious.
By zooming out even more, the two other major MAs I am paying attention to are the 200 and 400 WMAs. At the moment, getting to the 400 WMA seems a bit far-fetched as by that time the Fed will have probably stepped in to save the day.
Many are comparing the current hiking cycle with that of 2018, as the Fed kept raising rates until the market collapse and then it quickly stopped hiking rates, and in my opinion this is a decent comparison. Clearly not a perfect one as inflation is much higher, the Fed Funds Rate much lower, the Fed is about to start hiking by 0.5%, markets are more elevated and the global economy in a worse position than back then. The reason why I think this is a decent one and I want to compare it to 2018, is because I think the Fed is in a similar or probably worse position that back then, and therefore they will have to reverse course. Back then the market bottomed after a 20% from its ATHs and at the 200 WMA, which is currently 28% below the ATHs. On the chart below you can see what these corrections would look like when zooming out. I’ve also added what it would look like if we had a mega crash and the market retested the 2000-2008 highs, something I think is extremely unlikely at the moment. As our fiat system is crumbling, the Fed and the US government will be forced to print a lot of money, and therefore the stock market will keep going higher and higher, regardless of how bad the financial conditions are and how many deep corrections will it have.
Note
Here I'd like to add a few more things, as above it might seem I am extremely bearish, but I am not. At the moment I am not even sure the market is ready to go down right now.First of all, the VIX spiked and it could pull back a bit. On other analysis and on twitter, I've said it a million times : in this environment, the VIX under 20 is a steal. Hedging or outright shorting when the VIX goes there is a great strategy. I also believe that the VIX will eventually get to 48-50 in 2022 or 2023. It's pretty much impossible with the global economy so broken and the Fed hiking so aggressively, to not get a big spike in Volatility. However the recent mini spike from 20 to 28, might be enough for the market to bottom in the short term as many indices are also back at support.
At the moment the 100 & 200 DMAs haven't crossed on the SPX, but usually major death cross signal a bottom, not a top. So maybe when it occurs, the market will bottom. Below I have many occasions where this cross occurred, 2 of which where successful, one moderately successful and the rest big failures. The reason why this could be successful, is because the market bounced and failed to sustain above both MAs, and recently the SPX got rejected right at the 100 DMA. A key thing to remember is that the more times a bear signal fails like this, the more likely it is that it will eventually be right as most people dismiss it until it works.
Note
Although the current situation is a very unique one, due to Covid, Russia-Ukraine war, extreme stimulus in 2020-2021, that extreme stimulus being withdrawn and extreme supply shortages, Fed being determined to hike aggressively when the yield curve has already inverted... I believe we could be in a period that is a mix of 1937-1942, 2015-2016 and 2018.Essentially the war, too much debt, issues with commodities and a Fed determined to hike, would create something like it. That's why I believe 3900-4000 on the SPX is reasonable. The Fed meeting is on the 4th of May and therefore we could get another bottom a few days before the meeting, similar to what happened in March this year. Market was crashing and bottomed a few days before the meeting. As the rate hike is priced in, a lot of negativity could be priced in too.
At the end of the day most participants are aware that once something breaks in the financial system, the Fed will have to step in. Investors know that the Fed is cornered. Now in the final chart I am trying to see how cornered they are, as in my opinion the main thing they are worried about right now is corporate debt. US companies need to be able to borrow money and the Fed can't afford that market to break. However the problem is that junk bonds are now already trading below where they were trading at the 2018 bottom. The more aggressive the Fed is, the worse things are going to get. Getting below the 2016 bottom, which happened mostly due to energy companies going under, would be pretty bad. As HYG is filling a few gaps on the way down it might get some support, especially if stocks bounce hard. The more stocks do well and the less yields are rising, the more the US debt market can withstand major shocks. On the one hand the US economy is fairly strong and US corporations some of the strongest, but when the global economy has so many issues, inflation is already dealing a lot of damage on the profits of some companies, and on top rates are rising so fast, it is only normal for something to break.
Note
*Last few notesLQD (high grade corporate bonds, not junk) is getting near its 2015-2018 lows. Going below that, and especially below the Mar 2020 lows, then things could turn really ugly.
Finally, as you can see on the main chart, Tesla is still in an uptrend. Fell below the trend and has reclaimed it. Maybe when the trendline gets tested, that's where the bottom is. It is reasonable for a bottom to occur there, as both the debt markets are near support, while major indices are very close to sweeping major double/triple/quadruple bottoms, and these are the best ways to bottom. Sweep and moon!
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