2023-11-02 08:30:00 ET
Summary
- Risk-on sectors like technology and consumer discretionary are turning bearish, signaling potential trouble for the S&P 500.
- Short- and long-term yields are back in a bullish bias, which could cause a credit crunch, leading to a recession.
- The S&P 500's long-term price action has turned bearish, indicating a potential downward trend in the market.
- Investors must now brace for impact, as we could return to October 2022 lows. I explain why I'm no longer bullish.
It was only in early October that I was still anticipating a year-end rally for the S&P 500 (SPX) (SPY). However, I believe my thesis can no longer stand. I highlighted in my previous update that the S&P 500 entered its most favorable seasonal quarter of the year based on the market's history. However, I also indicated that it doesn't always work out that way. I believe 2023 could be one of those years where we must be prepared for a downbeat Christmas. And it could be a painful one. Here's why.
More Risk-On Sectors Turning Bearish
I cautioned in my previous update that Apple (AAPL) stock has a bearish price action signal on its long-term chart. However, that signal has also afflicted Microsoft (MSFT) stock. With AAPL and MSFT as the top two holdings in SPY, as they accounted for more than 14% of the market's exposure, increased caution is necessary.
Not just that, even the Technology Select Sector SPDR ETF (XLK) also showed a double top bull trap (double false upside breakout). Tesla (TSLA) buyers also failed to decisively defend its low $200s zone recently, even though buyers could still return. However, the momentum is with the sellers. Why? Because even the Consumer Discretionary sector (XLY) has turned bearish with a similar market structure. Tesla and its auto folks are losing support with dip buyers.
I also highlighted in a recent update on General Motors (GM) how GM buyers fled. Also, the usually robust ON Semiconductor (ON) stock was hammered this week, indicating broad weakness across the auto industry. It's no longer just Tesla trying to defend its volume, sacrificing margins; the whole industry could be in trouble. Coupled with the significant losses seen in lithium stocks, the writing is on the wall.
Short- and Long-Term Yields Back In Bullish Bias
Fed Chair Jerome Powell and his FOMC concluded their 2-day meeting yesterday (November 1), indicating a pause, and potentially an end to its rate hike regime. As such the Fed fund rates remain anchored between 5.25% and 5.5%. However, Powell also made it clear that the FOMC hasn't declared victory over inflation yet, and the door to future rate hikes remains open.
Given the resilience of the US economy, it does seem like we could avoid a recession. The pullback in the SPX has led to a normalization of its forward P/E back to the mid-17x zone, in line with its 10Y average.
Also, analysts' estimates suggest that the S&P could continue to record robust operating earnings growth in 2024 (+12%) and 2025 (+12.3%). I also shared in my previous update why I believe SPX is seemingly undervalued at the current levels. However, we all understand that in the near term, market volatility could lead to valuation dislocation for dip-buyers to capitalize on. In other words, if the market bias is still generally bullish, buying the dip is a reasonable strategy.
Unfortunately, with the 2Y ( US2Y ) and 10Y ( US10Y ) Treasury yields moving back into their bullish bias, investors need to be highly cautious. Despite the surge in interest rates, the Financial Select Sector SPDR ETF ( XLF ) has dropped close to its H1 lows. As such, the market has turned increasingly cautious on financial stocks, notwithstanding the surge in yields. I believe the market is pricing in an adverse scenario that something could break this time. Strategy Edward Yardeni highlighted in a recent commentary on October 26 that we need to be careful of the bond yields staying above 5%:
Bond Vigilantes more powerful than ever. The risk in the bond market is that the difference in the supply factor could push yields higher than 5.00%. That’s another way of saying that the risk is that the Bond Vigilantes will take over control of the market, pushing yields so high that they cause a credit crunch and a recession. - Edward Yardeni, 26 October 2023 morning brief
Do I believe that bond yields could stay above 5% for an extended period? I think it's too early to tell. However, if you look at the downward de-rating in REITs, as I updated in a recent article, we can no longer disregard that the market could take another steep downswing.
As such, the bullish bias of bond yields has coincided with significant bearish signals across risk-on and rate-sensitive sectors. Therefore, I believe we must be extra cautious now.
S&P 500's Price Action Turned Bearish
SPY price chart (monthly) (TradingView)
The culmination of these problems is seen in SPY's long-term chart (monthly timeframe). While the S&P 500 is near- and medium-term oversold as it closes in on its key moving averages, the long-term price action is now bearish.
That's bad news because, as an investor, I align my bias against what I believe the long-term trend looks like. Therefore, if the long-term trend has moved into a bearish bias, investors must be very careful.
As seen above, SPY failed to regain its 430 level in October 2023, confirming September 2023's bearish signal. Investors shouldn't expect a "straight-line" move toward SPY's October 2022 lows ($350 level). However, I urge you not to rule that out any longer.
As such, this is the time when I urge investors to consider lightening their portfolio or even consider hedging at appropriate resistance levels. Based on my discussion above, it's increasingly clear that the underlying sector headwinds have affected the market's bullish bias markedly.
It's time to brace for a deep impact.
Rating: Downgraded to Sell.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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SPY: From Bullish To Bearish - Why The Bears Could Be Right This Time (Rating Downgrade)