Technical Stock Market Commentary – 1/31/2022

Once in a while one of my colleagues asks me to write a more technical market commentary for them. I created one last week discussing the recent market drawdown through January and what I expect to happen next. Enjoy!

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On the heels of an already turbulent January for stocks, many were looking to the Federal Reserve to calm markets down last week during their monthly meeting.  Unfortunately, Chairman Jerome Powell added to investor nervousness by highlighting interest rate hikes will happen “soon” and that the labor market could withstand several rate hikes without being materially impacted.  This led to further market volatility, with Industrials and Utilities dropping further, while Energy stocks, bolstered by higher oil prices, reached new multi-month highs.  With the Fed’s January meeting and the peak of earnings season now behind us, what’s next for stocks?

Although the market decline through January has been intense, the evidence suggests that recent declines are not part of a larger, longer-term bear market.  Relatively fewer stocks participated in December’s market (Figure 1) rally, but the breadth deterioration was not severe enough to portend a major bear market.  Breadth was weakening for about two months before the January correction.  Prior to a bear market, breadth tends to weaken for at least four months, and often for over a year in advance of the market’s final peak.

Chart of S&P 500 versus NYSE Advance-Decline Line indicating that fewer stocks participated in the December 2021 market advance
Figure 1 – Breadth was weakening into the end of 2021, but not so much that it would be suggest a long-term bear market is underway

If breadth suggests the decline is only a correction, then prevailing sentiment and momentum suggest the correction may be in one of its latter innings.  To wit, the CBOE Put/Call Ratio (Figure 2) has been rising through January, indicating more investors are buying puts, which are helpful for hedging portfolios against market declines.  During panics, this ratio often spikes higher.  A ratio reading above 1.35 would be indicative of the kind of panic often observed at significant market lows.

Ratio of puts to calls traded on the CBOE indicates investors are becoming more pessimistic, but the ratio is not at panic levels yet.
Figure 2 – More investors are buying puts to protect against further market declines, but the ratio is still too low to suggest the kind of panic observed at major market lows

Finally, various momentum indicators are nearing oversold levels.  For one, the % of NYSE Stocks Above Their 50-Day Moving Average (DMA) is at 23.51%.  Historically, readings below 25% have been associated with short-term market lows and readings below 10% with more meaningful bottoms (Figure 3).  Some price-based indicators, such as the Relative Strength Index (Figure 4), are already at oversold levels, suggesting the market may already be in bottoming territory.  Ideally, momentum, price, and sentiment indicators all confirm each other in showing oversold conditions.

Based on the percent of stocks above their 50-Day Moving Average, the market is slightly oversold
Figure 3- The % of NYSE Stocks Above Their 50-DMA is at a slightly oversold level
Chart of Relative Strength Index and S&P 500 showing oversold conditions
Figure 4 – Many price-based indicators, such as the Relative Strength Index (RSI), are already indicating an oversold market

The bottom line is that the weight of evidence suggests this correction not the start of a larger, longer term bear market.  Shorter-term though, option statistics are indicating increasing investor pessimism while many price-based indicators are already oversold.  Therefore, the market decline is likely approaching its concluding stages, though it still may take lower prices to entice buyers to step in and trigger a new rally.  A reliable sign a sustainable rally has developed is a 90% Up Volume Day, in which 90% of all NYSE trading volume is associated with stocks increasing in price.  Two 80% Up Volume Days may also provide proof of a market low.  Until such signs of reinvigorated demand appear, it may still be premature to begin deploying spare cash into stocks.

Christopher I. Diodato, CFA, CMT, CFP

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