Making the case for a bear market rally, not a new bull run

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Thursday, August 18, 2022

Today’s newsletter is by Jared Blikre, a reporter focused on the markets on Yahoo Finance. Follow him on Twitter @SPYJared.

After a nearly 25% rally off the June lows, the Nasdaq Composite (^IXIC) took a step back Wednesday with its worst day in nearly three weeks.

And while it’s too soon to throw in the towel on this two-month rally, there’s a growing chorus of Wall Street strategists warning stocks have come too far too fast, and are due for a pullback.

Worse yet, some professional money managers expect a test of the 2022 lows with significant downside follow through should they break — which could amount to a drop of 25% from current price levels.

Katie Stockton, founder at Fairlead Strategies, recently joined Yahoo Finance Live to give some longer-term context to the current bullish moves. Stockton is impressed by both the momentum of the rally and its breadth — or number of stocks participating to the upside.

If this is the beginning of a new bull market, Stockton would want to see more of the same.

“If we started to see a lot of breakouts across the board that seem to have some staying power, that would be one encouraging factor,” Stockton said.

While Stockton concedes we don’t yet know if this is a classic bear market rally or a bullish reversal — longer-term charts suggest more downside.

On Tuesday, the S&P 500 kissed its 200-day moving average, a key technical level from which it promptly sunk. Stockton notes that the slope of that average is pointing lower — the opposite of what you want to see in a long-term bull market.

Stockton is eyeing the 3,815 level in the S&P 500 as a potential retest zone being discussed by market technicians. But if these lows are broken decisively — meaning stocks spend a couple weeks below this level — we could easily see materially lower prices.

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“Unfortunately, the next support level is around 3,500. But the secondary support level would become 3,200 … So with a breakdown below 3,815, that would then target about 3,200 based on next support.”

That 3,200 level would be 34% down from the S&P 500 all-time high and 25% off Wednesday’s close.

Strategists at Goldman Sachs, meanwhile, recently outlined seven reasons stocks are in a “perfect storm” to benefit from money flows into the end of the month — including expected institutional money flows as well as retail investor FOMO. Yet, equities investors face several headwinds as we head into this Friday’s monthly options expiration and attempt to ride out the historically volatile month of August.

August is seasonally an outlier when it comes to the performance of the major averages, and outside of September has historically been the year’s weakest month. Liquidity tends to be low with vacations and new school years preoccupying many traders, creating the conditions for volatility spikes.

So far this month, we’ve seen the opposite — as volatility has trended lower with rising stock prices.

Notably, the CBOE Volatility Index (^VIX) has plummeted from the mid-30’s to just below 20, only slightly above its lowest levels of the year. It would not be uncommon to see an upside reversal from here in the VIX that would be concurrent with another leg lower in stocks.

Monthly options expiration this Friday could be another bearish catalyst. For technical reasons, bets on the future direction of the S&P 500 will be rolling off traders’ books, potentially leading to greater volatility.

Further, Stockton hammers home a tried and true trading maxim — when markets bottom, it’s a process, and not the result of a singular event. Stockton doesn’t believe this process is complete given we’re currently seeing the greatest downside momentum since the Global Financial Crisis in 2008.

“We want to make sure that there’s some kind of bottoming process. We don’t think this is something that can end in a V-bottom type of fashion with the June low being the last low of the bear market cycle. We think there will be some kind of retest, and that’s important as the market sort of absorbs a long-term oversold reading,” Stockton said.

Given the unpredictable nature of markets, a rally to fresh all-time highs isn’t impossible, but simply unlikely. More likely is this market continues to frustrate investors — sometimes to the upside, and more often to the downside.

What to Watch Today

Economic calendar

• Initial jobless claims, week ended August 13 (265,000 expected, 262,000 during prior week)

• Continuing claims, week ended August 6 (1.428 during prior week)

• Philadelphia Fed Business Outlook Index, August (-4.5 expected, -12.3 during prior month)

• Existing Home Sales, July (4.85 million expected, 5.12 million during prior month)

• Existing Home Sales, month-over-month, July (-5.3% expected, -5.4% during prior month)

• Leading Index, July (-0.5% expected, -0.8% in during prior month)

Earnings

• BJ’s Wholesale Club Holdings (BJ), Applied Materials (AMAT), Bilibili (BILI), Estee Lauder (EL), Kohl’s (KSS), Melco Resorts & Entertainment (MLCO), Nio (NIO), Ross Stores (ROST), Tapestry (TPR)

Yahoo Finance Highlights

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