There Could Be Light at the End of the Tunnel

There are a lot of reasons to be bearish on stocks, but those stories have been circulating for months. For instance, the Fed's dramatically hawkish stance triggered a bond-market calamity and the Russian invasion of Ukraine put flames on the inflation fire while dramatically increasing geopolitical risks. Further, we've witnessed never-ending lockdowns in China. While we don't know what we don't know, investors have had plenty of time to digest the current news cycle and react accordingly. Yet, thus far the S&P 500 correction has been well within the lines in regards to historical pullbacks, which tend to average about 13%. We are also getting into the heart of earnings season, which could act as a stick save to the market (markets in a trough tend to find support from quarterly earnings) and seasonality is overall supportive. Throughout history, the market has put in some significant bottoms in March; so far we are holding the March 2022 lows but the jury is still out. Additionally, some of the stories that led to corrective action in stocks might have run their course. We've seen signs of stability in the interest-rate market in recent sessions and commodity prices have moderated. It should also be noted that the Fed hasn't always been able to follow through on its rate-hike campaign ambitions (remember 2019/2019?). Perhaps the market has priced in more rate hikes than the Fed will be able to, or need to, deliver. To be clear, we are not expecting all blue skies from here, but we do think the market is in a holding pattern in which we could see some surprising strength into resistance areas. Nevertheless, the upside potential is far less than investors grew accustomed to in 2020 and 2021. VIX The VIX (Volatility Index) gives us a glance into the urgency of traders to buy put options for either portfolio protection or speculation. A higher VIX suggests market participants are stretching their budget to pay a higher price for downside put protection. The VIX spends most of its time under 20.00 but can see temporary spikes. Historically, the VIX has struggled to break above 35.00 to 40.00 but did during the Covid crash and the financial crisis. Nevertheless, any stock market selling accompanied by a VIX peak near 35.00 has generally resulted in a stock market recovery. While traders should remain cautious, we see a potential head-and-shoulders pattern in the VIX. A head-and-shoulders pattern is exactly how it sounds; it is a three-wave rally in which the two shoulders post lower highs than the middle rally (head). Traders believe a break below the neckline will open the door to swift selling. If this pattern plays out, the VIX could be headed back into the mid-teens. This would be a positive for the stock market. View Chart » View in New Window » Chart Source: QST Nasdaq 100 Monthly Although we remain optimistic in the intermediate term, we mustn't forget the big picture. Tech stocks led the market higher after the Covid correction and they could lead the market lower if support levels fail to contain selling (we aren't expecting this scenario). The monthly Nasdaq 100 chart is a nice reminder of where we are; the current correction is minimal relative to the rally from the March 2020 lows. Also, had the market moved at the same pace we saw from 2009 through March 2020, the uptrend line would be around 8,000! While we don't expect to see a selloff to that level, it isn't realistic to completely rule it out. Even a 50% retracement of the rally would put the Nasdaq 100 near 11,750, roughly 2,000 points lower. This perspective is necessary to avoid complacency. View Chart » View in New Window » Chart Source: QST Nasdaq 100 Daily The daily chart of the Nasdaq 100 is far less scary to look at than the monthly, but it is also cautionary. Monday's low held trendline support dating back to March of 2021 near 13,200. If positive earnings, seasonality, and a reversal of the extreme bearish sentiment come into play a break above 13,175 would confirm a trend change. From there, a run to 15,300 (a retest of the April highs) would be likely and a run to the downtrend line near 15,870 would be probable. However, it would take a dramatic shift in fundamentals to break above this level so it would likely be a place to turn bearish. There are no free lunches, if 13,175 fails to hold the next support level would be 12,500; if seen, this would be a highly attractive opportunity for the bulls. View Chart » View in New Window » Chart Source: QST S&P 500 Daily Monday's daily price bar on the S&P 500 was a textbook key reversal pattern; the market opened sharply lower and closed higher on the day. However, we have seen four of these since the correction began and the success for follow-through buying is only about 50%. Also, on those occasions, the rallies were short-lived. The best example was the March 15 low which produced a rally from 4,100 to over 4,600 before rolling over. Thus, while this is a bullish pattern, we can't get overly confident; the bulls will need a close over 4,420 to avoid a washout to the next support level near 4,000. If seen, this might be a price level to get more aggressively bullish. On the other hand, if momentum reaches 4,700 again, the bears will be active and the bulls shouldn't be greedy (again, this isn't 2021). View Chart » View in New Window » Chart Source: QST Although both the S&P 500 and the Nasdaq 100 are attempting to hold support levels, neither are technically oversold. The RSI (Relative Strength Index) is merely slightly oversold. This could suggest a trip to the second trendline support levels offered by the respective charts so traders should be prepared for such a move. Bottom Line It is hard to come to an overly bullish conclusion from the charts in which new all-time highs seem like an obvious outcome but there are indications that the equity markets are content with working off the froth created in 2020 and 2021 with a wide-ranging consolidation of gains.

There Could Be Light at the End of the Tunnel

The market is in a holding pattern in which we could see some surprising strength into resistance areas.

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