Since the start of 2023, the S&P 500 has jumped 6.2% and the Nasdaq has shot up 12.6%. The big gains are largely a function of the January Effect and the market's willingness to ignore mediocre earnings and inflationary economic news.
The positive price action has helped to promote a bullish market narrative. That narrative is that there is a Goldilocks economic environment in which inflation is not too hot and economic growth is not too cool. There is growing hope that a recession will be avoided even if the Fed continues to raise interest rates higher for longer.
That bullish narrative started to show cracks last week. After a steady diet of hotter-than-expected economic news and hawkish comments from various Fed members, the market finally reacted on Thursday when the Producer Price Index (PPI) came in hotter than expected and two Fed members stated that they think rate hikes of one-half percentage point should be on the table.
As we start the week, the big issue now is whether the bears finally will gain some traction. There was widespread speculation by major market strategists that poor earnings would trigger another down leg in the market, but that did not happen. While earnings were generally poor, they were not as bad as anticipated. That, coupled with very bearish positioning, helped to propel the market higher. There was record-setting short covering in recent weeks, but that has disappeared and we will see if the bears start to press again.
There is more economic news coming up, bond yields have been trending higher and the dollar has been rallying since the start of February. Technically speaking, the indexes are testing key support levels but are still holding.
There is early weakness on Tuesday morning following a negative response to Home Depot (HD) earnings. Walmart (WMT) also will report before the opening and will impact the market. Several other retailers are reporting this week, which will affect the market.
There are handful of things that we will need to watch for at this juncture. The first is the strength of dip-buyers. The market consistently has found very strong support on dips after hot economic data. It even roared back on a hawkish Fed and a hot CPI report. We must watch to see if that continues. If the market cannot shrug off bad news, then a downtrend is likely to gain steam.
Another thing to watch for is whether the market closes near the highs or lows. A series of weak closes is an indication that the trend is shifting.
Finally, we need to see if the bullish Goldilocks economic narrative starts to fall apart. This narrative is based on the Fed effectively navigating the issues ahead. The market seldom has that much trust in the Fed, and it has been unusual that it suddenly gained so much trust despite clear statements that the Fed does not have inflation under control.
Stay focused on price action. The market is at a potential tipping point, and we also have negative seasonality that could be a factor.
