2023-11-16 01:16:26 ET
Summary
- We are likely looking at the early innings of a multi-week equity rally. The price action after CPI confirms this.
- I expect the Dollar Index to drop back towards the 100 level.
- Small- and mid-cap stocks are breaking out higher, indicating improved market breadth.
Early innings of multi-week equity rally
I believe we are in the early innings of a multi-week equity market rally. The price action after CPI data was very assertive and has a distinct bullish bias.
The key chart to look at is the Dollar Index ( UUP ). A strong USD has been kryptonite for equities. As such, it needs to be on a downtrend for equities to put in a sustainable rally. The price action after the CPI data showed that the USD's near-term uptrend is likely over, and we might see a -4% drop back towards the 100 level.
The second ingredient needed to kickstart a multi-week equity rally is improved market breadth. This means that more stocks need to participate in the rally. Before CPI, mega-cap technology stocks were largely responsible for holding up the market. After CPI, small- and mid-caps broke out higher, which bodes very well for risk sentiment.
Below, I will go through the aforementioned charts.
Dollar Index's near-term uptrend likely over
First, the Dollar Index - we may observe that the USD broke above the 106 pivot initially in late September. July to September was a strong period for the USD, and it is no surprise that equities struggled in the same period.
Daily Chart: Dollar Index
However, after breaking above the 106 pivot, which is technically a bullish event for the USD, the USD's strength started to wane. Price became rangebound and broke back below the 106 pivot pretty quickly.
The selling accelerated after the CPI data. It was a very sharp selloff, and I think sellers are in control now. I will be very surprised if the USD manages to retrace its CPI loss in the upcoming weeks. The damage it took was pretty heavy.
From here, I am targeting the 100 psychological level, which is the lower bound of the USD's 2023 range.
Small- and mid-caps take off
Since early October, I wrote that the Nasdaq 100 ( QQQ ) was likely to make new highs. This was with the expectation that mega-cap technology stocks were likely to lift the equity market.
We may observe that QQQ has since recovered back to its July highs after the CPI data, and I expect it to go on to take out its 2021 highs.
Daily Chart: QQQ
However, looking at the price action after CPI, I am of the belief that the strength is broadening out to the small- and mid-cap stocks. This is an important ingredient in a bull market, as it shows healthy internal breadth.
To get a sense of how the broad market is performing, we may look at the Russell 2000 ( IWM ), where the largest holding is less than 1%. This is an index that is not dominated by stocks with oversized market caps, such as the QQQ.
IWM surged above its downtrend resistance on high volume after CPI. I would be very surprised if IWM loses its post-CPI gains in the weeks ahead, and I expect it to trend higher from here. It may suffer a few dips here and there, but I think we are looking at a near-term bottom.
Daily Chart: IWM
The ARK Innovation ETF (ARKK) contains smaller-cap, faster-moving growth stocks as compared to the QQQ. Price also broke above a key pivot after CPI.
Daily Chart: ARKK
Mid-cap stocks ( MDY ) show a technical picture that is very similar to IWM, breaking above its downtrend resistance. We may see a bit of consolidation around current levels, but the trend is now higher.
Daily Chart: MDY
Overall, the price action across different asset classes - including the USD and small/mid-cap equities - shows that it is very likely that we are looking at a near-term bottom in the equity markets.
After the surge in strength post-CPI, I expect a bit of consolidation around current levels to digest the gains. I would, however, be very surprised if equities and USD manage to entirely reverse their post-CPI price action.
For those that missed out on the rally so far, do not fret. There will be many opportunities to get long if this rally does have legs. Wait for the market to consolidate and set up again. I would definitely not want to short equities right now.
For further details see:
Early Innings Of Multi-Week Equity Rally (Technical Analysis)