AFMC - The Fed: Leading The Stock Market To Another Drop

2023-04-17 15:38:57 ET

Summary

• The recent economic data hasn't been good.
• Also, we passed the phase where "bad news" was considered good news for stocks.
• The market is not ready for higher rates for a more extended period, and the Fed must provide the pivot soon, or else.
• More panic selling could break out if the economy worsens, as we may see a deeper recession than previously anticipated.
• The stock market will likely go for a "double-dip" bottom unless the Fed reverses monetary policy soon.

You've probably kept up with the recent economic data, but in case you have not, it could be much better lately. We have heard the R-word more often recently as many economic indicators strongly suggest that the economy is heading for a more significant slowdown in 2023. Furthermore, "bad news is bad news" again as the Fed hesitates to halt its tightening process despite higher rates pressuring markets significantly. Moreover, things have become so bad on Main Street that they affect earnings on Wall Street.

In addition, the market has a potential banking crisis to deal with. The Fed needs to adjust its ultra-tight monetary stance promptly to prevent the economy from dropping into a deep recession. Also, there's a high probability that the S&P 500/SPX ( SP500 ) and other major stock market averages could experience more volatility and sustain additional transitory losses as this bear market continues grinding in 2023.

The Technical Image - A Critical Showdown

The Nasdaq 100 - This major average has big-tech and other significant stocks that trade on the Nasdaq. Since these names are often the market leaders, I frequently look to the Nasdaq 100 for broader market direction. Therefore, as a significant portion of the S&P 500 are technology stocks, where the Nasdaq 100 goes, the SPX typically follows.

The Nasdaq 100: 1-hour chart

The Nasdaq 100 is around a critical inflection point here. Right above is the crucial resistance level at 13.3-13.5K. However, the solid support permeates the 13-12.5K region. Therefore, there's a limited downside beyond this region in the Nasdaq 100. This dynamic is excellent for accumulating high-quality, badly beaten-down Nasdaq 100 names. Some of my favorite tech stocks include recent picks toward their bottom , like Tesla ( TSLA ), Nvidia ( NVDA ), Meta Platforms ( META ), and many other tech names.

Now, let's put things in perspective. The Nasdaq 100 has skyrocketed by approximately 28% from its mid-October low, and the "bottom" may be in for many quality tech socks. However, we will still have more volatility, corrections, and buying opportunities.

The Nasdaq 100 could correct to around the 12-12.5K range without breaking its bullish uptrend. Therefore, we could see some exciting buying opportunities ahead. Thus, the good news is that many quality tech stocks may have bottomed, and we should see more compelling buying opportunities in specific companies as we advance.

Now, The Bad News

The economy continues to worsen, and it's unclear if the Fed can ensure a soft landing, preventing another disastrous recession. Stock markets don't like uncertainty. Moreover, the Fed's ambiguous stance and time frame for the "pivot" may add to the volatility flames from here. While the Fed's rhetoric remains relatively hawkish, the bond market has something much different in mind, and I'll bet that the bond market is right here.

The Recessionary Rate Inversion

The yield inversion shows short-term rates spiking, a temporary phenomenon not likely to last long. It's unrealistic to expect rates to stay high for long, and the bond market illustrates that a recession is expected. Long-term bonds that provide more security are experiencing significant demand, implying that the bond market foresees a lower-interest rate environment in the coming years. There has been some excellent progress regarding bringing down inflation recently. However, the Fed's aggressive monetary policy is cooling the broader economy too much.

Too Much Red - A Clear Caution Signal

April began with horrible ISM manufacturing numbers. The worst part of the report was the ISM manufacturing employment, coming in below 47, well below the wishful estimates of 50. This dynamic illustrates that the manufacturing portion of the U.S. economy is in evident contraction. The latest manufacturing reading suggests that production-related jobs and employment in many fields are being reduced. This dynamic implies that the consumer and labor market should continue worsening from here.

The Labor Market - Likely to Worsen from Here

While the miss was minuscule, the latest nonfarm payrolls report missed estimates. Furthermore, private nonfarm payrolls missed estimates by about 12%, a substantial margin. Also, the bar is relatively low here, the labor market is barely expanding, and we could see a turn toward a contraction soon. Therefore, this may be one of the last "constructive" job reports, and the stock market will likely become more volatile if nonfarm payrolls turn south.

The employment trend is worsening, and a contracting number could send stocks lower from here. Also, we must constantly monitor the consumer's wellbeing, and the most recent retail sales missed badly, coming in at -0.8% MoM over the expected -0.3% read. Therefore, as high inflation and elevated borrowing costs take their toll, the consumer side of the economy is slipping deeper into a recession.

Could Earnings Save The Day?

All eyes are on earnings now as the big bank and other notable results roll in. While we saw better than anticipated results from JPMorgan (JPM), Wells Fargo ( WFC ), and other significant institutions, the worst of the financial cycle may still be ahead. Therefore, I'm cautious about the financial sector here, and there' s no convincing evidence that the worst has passed. While other earnings, such as tech, could propel some stocks marginally higher in the near term, whether the overall market gains would be sustainable in the near term is questionable.

The Bottom Line: The Inflection Point Approaches

The SPX is approaching its most significant resistance level since the bear market began more than one year ago. If SPX punctures through the 4,180-4,200 resistance level, the major average will go over the 20% (from the bottom) mark, officially kicking off a new bull market in equities. This dynamic could provide a breakout opportunity for many quality companies. However, there are doubts that there's enough juice to pump stocks higher in the near term, especially with all the uncertainty on the horizon.

Furthermore, there's insufficient clarity on the Fed's "soft landing" plan, and the economy could hit a rough patch for several quarters. Now may be an excellent time to remain cautious in the near term, especially with increased tension on the horizon. Nevertheless, we should remain vigilant for opportunistic intermediate and long-term buying opportunities. My "bottom-out" target range for the SPX remains 3,000-3,500.

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