Technical Strategy Video:

Reasons for Optimism, yet a bottoming process takes time

Key Takeaways

  • Monday’s reversal was a technical positive after multiple down days, but a retest looks likely, and should provide better buying opportunity on any weakness into FOMC
  • Breadth, momentum, and Fear indicators starting to signal a trading low is close
  • Signs of capitulation should be in place by Feb. 2022 to suggest a more meaningful low 

Bottom line- Carving out a meaningful trading low takes time.  While many are eager to buy dips after a 10% decline in 14 trading days, many times its better if no one wants to buy the dip from a trading perspective before one’s in place.   Monday’s reversal was encouraging, but three factors stand out as being problematic as to thinking “The Low” is in, and a move straight back to highs is imminent.  First, a lot of technical damage has taken place and momentum is still quite negative and breadth remains poor.  Second, Elliott-wave indicators suggest markets have formed only three waves thus far from January and a retest and break of lows can still happen into early February.  Third, DeMark indicators are early to line up to show exhaustion based on TD Sequential and TD Combo indicators.  Thus, while there’s a lot to celebrate given some capitulatory readings in many breadth and sentiment gauges starting to come together, trying to buy dips into this decline likely won’t be as easy and should be fraught with retests.  Pushing back to new lows which shows positive divergences in momentum and breadth is an additional key part of the bottoming process, for which I’m awaiting more evidence.

Reasons for Optimism, yet a bottoming process takes time
Source: Trading View

Technically positive factors starting to line up to expect that meaningful lows aren’t that far off.   Overall, while a few things remain troubling, a number of factors have started to come together that are promising:  

Momentum is now officially back to oversold levels on daily charts.  Relative strength index (RSI) readings are now under 25 on daily charts, the lowest levels in 22 months

Breadth has nose-dived to capitulatory levels.  Percentage of SPX issues above their 20-day moving average (m.a.) hit 13% after Friday’s close and could likely move into Single-digit territory this week on further weakness.

Technology as a sector vs. SPX (as viewed in Equal-weighted terms) has now declined down to an intermediate-term area of support going back since 2016, which is important support

VIX Curve has now shown its first evidence of inversion which often can be important in signaling that recent fear based on implied volatility’s spike is getting overdone.

Equity Put/call ratio finally hit above 1.00 last Friday, 1/21/22 which is a key part of the puzzle in my toolkit for when to expect that trading lows can occur. 

High Yield spreads remain largely muted, and in very good shape compared to prior Equity market drawdowns.  Normally, credit starts to waver ahead of major market selloffs, but has shown little to no real “alarm bells” going off this time around.   As shown below, the Ratio of  LQD -0.09%  (Ishares IBoxx Investment Grade Corporate Bond ETF, relative to  HYG -0.22% , the Ishares High Yield Corporate Bond ETF) has barely budged in heading higher.   This looks to be a much more stable situation than March 2020, or even Winter of 2018.

Reasons for Optimism, yet a bottoming process takes time
Source: Optuma

Breadth measures are reaching “It’s so bad, it’s good” levels, for trading purposes.

The percentage of SPX issues above their 20-day moving average (m.a.) has nose-dived to 13 as per last Friday’s close (1/21/22) and might drop to single digits this week.  That’s a fairly low number and combined with RSI levels below 25, should represent an upcoming buying opportunity.

Meanwhile, the percentage of SPX stocks above their 50-day m.a. is under 32% while the percentage above their 200-day m.a. is less than 50%.  Thus, a lot of damage has been done in a relatively short period of time.  While this matters more on an intermediate-term time-frame, it’s hopeful that this might recover strongly on a bounce into mid-March.

Reasons for Optimism, yet a bottoming process takes time
Source: Optuma

Relatively speaking, Technology’s breakdown has not violated major long-term support vs. SPX but lies near real make-or-break levels.  

The chart below highlights the relative ratio of Invesco’s Equal-weighted Technology ETF (RYT) vs SPX and looks to have pulled back to levels that have held every time thus far on pullbacks since 2016.   This is yet another piece of the puzzle that’s encouraging after the recent selloff in US Stocks.  Tech looks to be holding where it needs to.  Monitoring this into end of Q2 will be important.

Reasons for Optimism, yet a bottoming process takes time
Source: Optuma
Disclosures (show)

Get invaluable analysis of the market and stocks. Cancel at any time. Start Free Trial

Articles Read 2/2

🎁 Unlock 1 extra article by joining our Community!

You are reading the last free article for this month.

Already have an account? Sign In

Don't Miss Out
First Month Free