FANG - S&P 500 Could End Full-Year 2023 In The Red: How To Capitalize (Technical Analysis)

2023-08-22 12:41:54 ET

Summary

• Yes, I believe a 15% year-to-date gain in the S&P 500 could evaporate by year end. Not will, but could. I show you the charts as my evidence.
• Big money managers and hedge funds have caught up with the rally, but there are signs of exhaustion and a potential market rollover.
• Inflation may be reviving, and the bond market is increasingly likely to draw money/liquidity out of the equity market. But there are ways to capitalize.

The S&P 500's price pattern is starting to remind me of one of those old gangster movies. To paraphrase and put it in stock market terms, consider this. The S&P 500 closed last Friday at 4,404. It closed the year 2022 at a level of 3,839. That's about a 15% gain year-to-date since through last Friday.

But here's what I think (doing the best mobster voice):

15%? That's a nice profit.

It would be a shame if something happened to it.

Back on June 5, I wrote "Buy Summer, Sell Autumn" to express my intermediate-term view of the stock market. Things were moving right along. Until two months later. That's when, as the mob boss might say… an unfortunate incident occurred. That incident was a surge in the 10-year US Treasury bond yield. Here's what happened next.

Now, this is "merely a flesh wound" on the stock market's strong run so far this year, to quote an old Monty Python phrase. But this was just the shock, the immediate market impulse reaction. I think there's an excellent chance that between now and year-end 2023, the next four months, this will become a big issue for the stock market. So big in fact, that it could drop the S&P 500 to and even through the level at which it started the year. Translation:

2023 might end up being the second down year in a row for the S&P 500

I'm a technician/chartist for 43 years, back to the days of pencils and graph paper as a teenager. So I've seen a few chart patterns. One thing every investor should prioritize, whether they are an avid chartist, they think technical analysis is voodoo, or somewhere in between, is this:

The market can go up at any time, but the difference at any point is how much risk of major loss is attached to that return potential. Recent technical/price movement in some key market areas has brought the possibility that autumn starts early, so to speak.

As for the fundamental reasons for this? I'll let that crowd fight it out. This is about the technical picture, right now. To that end, know this:

1. Sentiment is still way too high. I'm not referring to a particular sentiment indicator, but rather to the continued penchant for buying the dips. Financial television continues to be like a rush to see who can throw around phrases like "it's a buying opportunity" and "the market's on sale."

2. Big money managers and hedge funds have been playing catch up for missing the first half rally - but they caught up really quickly, so now there are signs of exhaustion and a market looking more like it is poised to "roll over."

3. Inflation is not only not dead, it might be reviving.

4. The "big kahuna" in all of this is interest rates, and by association, bond rates. And they're threatening to break out on the long end, big time. That has spillover effects to the stock market.

So, let's take a look at some pictures, and do so while using what we consider to be "technical analysis" but without a heavy dose of technical jargon! As I see it, anyone can look at a chart and tell you what the prices say. To me, it's more a matter of looking at tons of charts of ETFs, stocks, and interest rates as I've done for decades, and draw some conclusions about the "story" the markets are telling us. I'll summarize that below, since sharing hundreds of charts I run through regularly is not a good fit for this space.

Where we've been

From back when I wrote the "Summer/Autumn" article until the rally halted in late July, there was a very encouraging development in the stock market. Participation! That is, it was not just eight huge stocks getting bigger, while the rest of the market cancelled each other out (a winner, a loser). As you can see here, the average S&P 500 stock (equal weight) outperformed the cap-weighted index. And the Dow did not get trounced by the Nasdaq as it has been much of the year. They were about even.

Alas, this may prove to be short-lived. But let's take a step back.

Because 2023 has been as emotional a ride for investors as we can remember. That's probably because investing-related communication is everywhere. And, while most of what you find in the Seeking Alpha comments sections contributes toward a better, more informed marketplace, there's a lot of hype and snake oil salesmanship, not to mention the constant "talking one's book" in the outside world, on social media platforms and of course on financial television. If you spend as many hours as we do seeking it out and absorbing it to get a pulse of market sentiment, it surrounds you.

But that's one reason I think the current environment may catch some bulls napping. And the charts are starting to show it. I suspect that many investors would not believe the chart below unless they actually saw it. And that's why I'm showing it.

This is Microsectors FANG+ ETF ((FANG)), a lightly-followed ETF that tracks what have been the hottest stocks in the market all year. Thus, while the ETF itself is not our focus, FANG's value as a proxy for this "sexy" part of the stock market, and the AI-driven craze that allows pundits to justify nosebleed valuation levels for these stocks, is very valuable to me. I use FANG alongside ((QQQ)), ((SPY)), ((RSP)), ((DIA)) and about 150 other ETFs to truly drill down into the stock market every day, and seek what I believe is what investing is all about:

The market tells us a story. Charts are the storyteller.

The bottom line on the FANG chart is this: in the past 30 months (2 1/2 years), its total return is below that of T-bills. Naturally, since FANG and other tech-heavy market segments can be very volatile at times, there were shorter time frames in this 30-month window when FANG crushed the return of nearly any ETF. And the S&P 500 was actually up about 12% total during this period. 12% total in 30 months, that is.

The takeaway is that we're not currently in the midst of a roaring new bull market. Every pullback is not a buy the dip moment. If it was, the S&P 500 would have made more progress in the past 30 months than it did. This is still a bear market environment, and bear market rules apply. When will that guideline end? Perhaps when we finally break through the old highs (4,800 on the S&P 500) with gusto. But that could be years from now. So my guiding rule continues to be to play offense and defense at the same time, all the time. Why? because as this very contemporary reminder indicates, the best way to pursue strong long-term returns is to not lose big along the way.

What's the market saying now? And how can we listen well?

The S&P 500 closed last Friday at 4,404. It closed the year 2022 at a level of 3,839. I see a path for it to close below that level, perhaps significantly below it, by year-end.

Most of this year's market return has come since March 27, the date the Fed signaled all bank deposits would be insured. That was essentially like an additional dose of quantitative easing, or a Fed put if you will. It stoked the rally. Now, reality may be setting in.

But the over-arching concern that equity investors should have is this: For many types of investors, the bar for allocating a lot of one's portfolio to equities has gotten much higher. First it was T-bills at 5%. That was refreshing and new. But now, the 4%-5% return is stretching out along the yield curve., with most of it over 4.5% as of this writing. And, for those willing to take on credit risk (not me!), there are additional returns to be had.

The big risk for the stock market: Competition from the bond market

Many investors can't even remember when bonds were a consideration. But they are now, and to quote the late, great rich business guy and politician Ross Perot, that "giant sucking sound" you hear the rest of the year is money flooding out of the stock market and into bonds. And, from what I see in the charts, there's plenty of downside.

What I see above is a market that is threatening to roll over at an accelerating rate. That's the top part of the chart, on the far right side, in the rectangle. And you can see that 3,800 and even the 2022 lows around 3,600 are not terribly far away. Markets that zoom higher have the risk of zooming lower.

The smaller rectangle in the lower part of the chart simply says that momentum has been lost, and that it will probably take a strong effort to get it back. It can certainly happen. But the weight of the evidence, from this and hundreds of other charts I've been pouring through, favors more downside as September approaches.

How to capitalize

If what I see starting to develop has some follow-through, the best way I know to profit from it is either by owning put options (I own a decent slug on the S&P 500 and Nasdaq 100, as well as on several ETFs and individual stocks that I think are especially vulnerable). But single-inverse ETFs like the ProShares Short S&P500 ETF ( SH ) are about as straightforward a move as I can think of. It aims to perform opposite the S&P 500. So, S&P 500 down, SH up. Naturally, the opposite is also true.

And, while I've focused on the S&P 500, ProShares Short Nasdaq 100 ETF ( PSQ ) is another consideration. After all, given the Nasdaq-heavy influence on the way up, a market plunge into year-end would likely be a case of the bigger they are, the harder they fall. And given the dominance of the Nasdaq's biggest holdings this year, they are the biggest, and should fall the hardest.

But those are just individual securities. I think that the real takeaway, as is the case with everything I write here, is that any ETF or macro market strategy needs to be personalized by the investor themselves. Securities are just the tools of the trade. The key is to take this and other folks' views into account, and apply it to your own situation. That means having a strategy that includes the ability and willingness to play defense, not just play offense and pray away bear markets. Because I'm pretty confident we are still in one.

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