Has There Been Any Change In The Market? (SPX)

Justin Sullivan

Technical Note – Has the market changed yet?

New sell signal from tech stocks reflects prior reversals in the market.
Conditions are similar to the top in ’00, and ’07.
Valuation at a level beyond almost any fundamental security.
Heavy government funding and yield curve inversion in the next 6 weeks signal trouble to come, especially for long-dated assets

(Tradingview.com)

macro perspective

Market conditions are behaving in a similar fashion to the 2000 and 2007 top periods. Nvidia’s (NVDA) recent performance, leading up to and following a truly impressive quarterly report, brings back memories of many of the tech bubbles we’ve studied and many of which we’ve experienced. Rates are at a relatively high level, but arguably well below sustainable levels given the current structure of inflation expectations. Consumer spending appears to be turning around after three years of massive stimulus. The labor settlement suggests substantial potential for higher inflation along with other components such as food and energy costs that continue to rise. It appears that long bonds are one of the first bearish markets not driven entirely by the Fed since the ’08/09 time frame.

A key aspect of the current debate about economic conditions is jobs, which strengthened more than expected after the Fed rate hike. Bulls argue that no recession comes with such a low unemployment rate. Bears say the numbers are probably flawed or that the decline in openings is a bearish sign. We believe strong jobs reflect middle class second or third jobs, which appear in the data as full-time employment. Despite strong jobs, the GDP/GDI average is showing signs of a slowdown.

Commodities such as oil are showing an uptick, which could lead to higher inflationary costs for consumers and further complicate government deficit financing efforts ahead of the pre-election stance. Geopolitical risks to oil prices are potentially rising as BRICS and OPEC try to gain an edge over the West. If China’s stimulus efforts are successful, oil is likely to rise; If not, the relief could lead to a reduction in commodity profits. Either way, we look forward to a more challenging 2H23.

Inflation will not go away so easily

Recent reports showed signs of continued inflation. Earlier the general consensus was that inflation would come down to 2% relatively soon. Should it not continue its decline, the Fed will need to continue with rate hikes as it suggested in testimony this week, due to several potential areas of risk noted above. The potential downside pressure from higher rates on long-dated assets such as tech stocks, PE and VC portfolios and long bonds could be considerable. Food prices continue to rise, while wage demand is further pushing up the components of inflation.

Since T-bills also substantially underestimate the real rate of inflation (see shadow government statistics), investors will generally need to reach yields to cover the loss of purchasing power, which bond holders take very seriously. Are. However, the current 10-year rates also cover current inflation using the CPI. As the government sells large amounts of new debt and refinances maturing debt, the market has become much less welcoming than before. We believe that the yield can be increased further.

Interest in the last 4 quarters is $3.2t(!) or 50%+ of the F23 budget or a shocking 65% of total tax receipts last year). The twin effects of a reduction in debt service costs and a new Fed rate hike in the federal interest payment budget could seriously hurt long-dated assets like tech stocks, PE/VC funds and long-dated bonds.

We believe this is a powerful downside motivator posing a risk to markets, which have largely ignored the huge gap between actual inflation and valuations based on accurate readings of the risk-free rate. The valuations of tech stocks, such as Nvidia’s incredible 20x sales, represent the kind of risk we last saw during the final days of dot.com and the 2006-7 housing era.

Trends suggest weakness of the dollar against the euro

Our proprietary supply/demand model suggests that the USD may face further downside pressure in the coming months. With SPX and technical patterns for tech stocks reaching double top or nearly so, we think the possibility of fresh sell signals could warn of a significant correction to the downside.

S&P500 Weekly Supply/Demand Chart

The stock is in a long-term sell signal with room for downside (Source: Summit Analytic Partners Research)

Volume-Adjusted Price Weekly Chart

Momentum (green) is bearish – VAP (red) is testing its trendline support from the recent rally (Source: Summit Analytic Partners Research)

Our weekly SPX model is showing a long term sell signal which suggests that the market may trade significantly lower on the downside. We are worried about the scope for further downside till meaningful support is found. Similarly, Nvidia’s trading action following its remarkable EPS report is telling from the perspective of several technical bubble tops. Traders are selling heavily, this is a better upside surprise than anything we’ve been missing, indicating to us the real possibility of a major change in outlook for long-term assets not seen in decades That could prove to be detrimental for tech stocks trading at valuation levels. ,

NVDA Weekly Supply/Demand Chart

At 20x sales (!) there is ample room for LT sales drawdown (Source: Summit Analytic Partners Research)

Volume-Adjusted Price Weekly Chart

Momentum (green) is bearish – VAP (red) is falling sharply – Key support is well below (Source: Summit Analytic Partners Research)

NVDA supply/demand sold off in mid-July and yielded only a modest jump in August’s rally. The fact that support is so far away bothers us as we consider the higher rates. Money flows are slowing down drastically, but there is still a long way to go until a more constructive pattern can provide support. Clearly institutional demand for stocks and especially NVDA is falling in August.

Euro/Dollar Weekly Supply/Demand Chart

Selling pattern shows scope for further weakness in US Dollar (Source: Summit Analytic Partners Research)

Volume-Adjusted Weekly Price Chart

VAP is falling but slightly slowly – Momentum (green) is turning bearish again (Source: Summit Analytic Partners Research)

risk

Liquidity and anti-inflationary deficit spending from infrastructure is a powerful force in the market. Recent signs of consumer weakness, interestingly at the highest levels for a change, suggest the stimulus may eventually taper off after a massive surge. We believe that the market is signaling that the liquidity cycle may be ready for a reversal following the huge deficit caused by higher government spending. If so, we can expect fundamentals to reassert themselves strongly given the extremes in valuations. Once they do, expect stock valuations to have a tough time. If not, our thesis could get delayed for weeks or months.

Despite outperforming expectations, we have seen three quarters of weak earnings. With margins under pressure and inflation running well ahead of Fed rates (especially using 1980 metrics that show the CPI to be nearly double the Greenspan version currently used), valuations are surprisingly high and is subject to substantial negative adjustments if the influx of purchasing power slows. We believe that the early summer highs and the heavy institutional distribution of stocks may signal a shift in risk tolerance in seasonally dangerous declines. But the Atlanta Fed’s GDP-Now indicator is showing a substantial uptick in economic growth that could undermine our and the market’s calculations.

A third risk to our outlook is that China’s economic challenges could develop into full-blown deflation, leading to a commodity selloff as it struggles to pay down foreign debts. If commodities begin to decline and demand for oil weakens, inflationary pressures may ease, at least temporarily. This would ease pressure on rates and help the Fed slow the level of economic activity further. We’ve heard from industry sources that as supply chains return to normal, higher cost shifts through value chains are likely. Thus, any easing of inflationary pressures would help prevent rates from rising further and reduce the revaluation of long-term assets in the coming months. We are still seeing ample signs of high inflation. For example, a recent survey indicated that a remarkable 63% of Millennials expect to change jobs this year for higher pay; 55% of older workers have the same expectations (Deloitte Global 2022 Gen Z and Millennial Survey). If inflation rises after a brief respite, central banks will need to raise rates further to destroy excess demand. In our view, the likelihood of a recession will accelerate, resulting in weak demand and a significant drop in stock prices.

Business

We believe that technical stocks such as the SPX and NVDA are headed for a correction over the next several weeks or months. The RSI is diverging bearish on the SPX, with the RSI reaching negative divergence at 7/26. By our modified Fibonacci methods, we count the SPX as a double top. Our proprietary supply/demand model shows a sell signal in the early stages, confirmed by the breakout of the bullish trend after 7/26. Volume-adjusted price signaled support and its momentum measure indicated a bearish divergence prior to price’s higher highs on the SPX. With so much room for lower levels, the weekly S/D could indicate that a powerful correction could be in the cards after this drop. Money flow also reflects a change in institutional selling over the past several weeks. More information about our technical calls is available upon request.

conclusion

We believe stocks are at risk of a correction that could reflect an impending recession in the economy. Government deficit spending will reduce liquidity in the market as new bonds are sold to investors over the next several weeks. Inflation could also factor into the equation, forcing the Fed to raise rates further. The impact of higher rates on corporate earnings, government budget deficits and consumer spending could be a powerful force that could threaten valuations that are at or near historic peak levels.