QQQ - Why The Market Could Tumble Again Soon

2023-05-08 17:19:25 ET

Summary

• The S&P 500, and stocks in general, came a long way since their October bottom, with the SPX appreciating by nearly 20%.
• However, not quite 20% is still shy of a bull market, and we're seeing signs that the economy could deteriorate as we move ahead.
• Moreover, is the Fed ready to play ball and pivot soon? The market thinks so, as it's pricing in about 75Bps worth of rate cuts by year-end.
• While this policy shift should benefit stocks, the Fed may not pivot as swiftly as the market expects, and that's why stocks could feel more pain.
• We should see more volatility in the months ahead, and the market could throw a temper tantrum, retesting prior lows if the Fed doesn't provide a pivot soon.

The S&P 500/SPX ( SP500 ), and the stock market, in general, are at a crucial inflection point. The S&P 500 has come a long way since its October bottom, appreciating by nearly 20%. Unfortunately, that's just shy of a new bull market. Moreover, we see increasing signs that the economy should worsen as we move forward. While the market anticipates a policy shift that would benefit stocks, the Fed may only provide a pivot once the economy and the stock market feel more pain. Therefore, we could see increased volatility in the months ahead, and the market could retest prior lows or even bottom at a lower level closer to 3,200 in a worse-case scenario.

SPX: 6-month chart

This chart concisely shows the significant volatility observed over the last six months. Moreover, we're seeing performance mainly since the "October Bottom," yet the volatility is immense. Also, it's worth noting that the rebound from the October lows has materialized into a gain of nearly 20% for the SPX, still shy of a new bull market. Also, I must point out the bearish head and shoulders pattern developing here.

If the SPX doesn't move above 4,200 resistance soon, momentum could worsen, bringing the major average below the neckline around 4,100-4,050 support. This dynamic would enable the SPX to test and potentially break critical support below the 4,000 level. If this crucial level folds, the SPX could retest the 3,800-3,500 and possibly even lower as we advance. On the upside, the SPX needs to break out above 4,200, but the upside may be limited here in the near term.

What Moved Markets Last Week

We saw an action-packed week, as the FOMC, jobs report, significant earnings, and other factors influenced markets. However, in my view, we did not see anything extraordinary or unexpected except for the nonfarm payrolls, which came in significantly better than expected .

Nonfarm Payrolls - Much Hotter Than Expected

Everything looked great with jobs, providing an impression of a better-than-expected labor market and the general economy. However, we should consider that jobs are a lagging indicator. Nevertheless, the numbers were substantial, with private nonfarm payrolls increasing by 60K more than expected. "The official unemployment rate" ticked down to an ultra-low 3.4% rate, as the economy added 253K jobs in April vs. the expected 180K. Also, average hourly earnings came in better than expected, illustrating that while inflation is present, employees' pay also is increasing, helping the consumer keep up with their buying power.

The Fed - Likely No More Hikes

While there's about a 15% chance the Fed will hike one more time, we're probably at the end of the rate hike cycle. Moreover, we will likely see rates coming down soon.

The consensus is that the benchmark will be about 4.25%-4.5% by year-end. Now, that's about 75 basis points below where the funds rate is now. Therefore, the Fed pivot will likely continue unfolding, leading to a lower target rate, probably starting this fall. The market expects the pivot now. So, if the Fed doesn't play ball, we could see a substantial stock market meltdown in the coming months. Thus, we want to see similar odds of lower rates or better as we advance here.

The CPI Could Influence Things

Crucial inflation data is coming out Wednesday. The CPI may be the most accurate of the significant inflation readings, which I prefer most. The market got a 5% number last month (March), and the consensus estimate is 5% for April. We need a number close to or slightly lower than the estimated figure. A 4.5-5% CPI print should get a decent reception on Wall Street. However, if we see the number fall too sharply, or if inflation comes in higher than expected, we could have a problem and other risk assets in the near term. A number too low could imply that the Fed did too much tightening, and deflation could be on the way, and a number too high could mean that the Fed will attempt to keep rates higher for longer, which isn't a bullish dynamic for the SPX and stocks in general. We'll also see PPI, consumer sentiment, and other crucial numbers in the coming days. Therefore, we have a data-packed week that could make or break this rally as we advance.

Earnings - Better Than Expected

Despite some banking and stock-specific issues, most earnings came in better than anticipated in Q1 . We saw powerful results from Microsoft ( MSFT ), Alphabet ( GOOG ), Apple ( AAPL ), and other tech giants, implying that the worst is probably behind the tech segment. Nevertheless, other sectors that held up relatively well during the initial stages of the bear market may see new lows as the later stages of the down cycle unfold in the coming months. Therefore, while earnings were mainly better than expected, many companies provided cloudy guidance, adding to the uncertainty on Wall Street and opening the door to further declines before this bear market concludes. I also must note that most of the "better than expected results" were only better because the estimates came down so much. Nevertheless, many companies are going through earnings recessions now, which could worsen as we advance in the coming months.

Bottom Line: Get Ready for Low Interest Rates, or Else

The market needs lower interest rates and is pricing in about 75 basis points worth of rate decreases by year-end. While the Fed hasn't been that vocal on easing anytime soon, the agency will likely come around as inflation moderates, the labor market and the economy worsen, and the stock market goes through another down phase. There's a significant disconnect between what the Fed says and what the market expects.

If the market doesn't get what it wants, we will probably see stocks and other risk assets undergo another wave of declines. Additionally, the economy continues worsening, despite some better-than-anticipated figures coming in. Bad news isn't bad news anymore. If crucial data points continue deteriorating, there is an increasingly high probability that the stock market will see more near-term declines. My base case bear market bottom target range remains 3,500-3,200, and my year-end price target remains around 4,500-4,600 in the SPX.

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