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Mish's midweek update: Introducing my Economic Modern Family

Mish's midweek update: MarketGauge's Mish Schneider offers her expert analysis of US markets.

By this point, the plethora of conflicting views from market analysts on news channels and social media is enough to make your head spin.

Yields have fallen, stock index support levels have held, inflation remains a concern, the threat of deglobalisation looms, and earnings for US stocks are significantly underperforming.

Where does all this leave us, the retail investor? The macro picture, looking at overall trends based on fundamental factors, is crucial. 

Although it’s been said before, price and momentum truly are the purest indicators that investors and traders can use to attempt to forecast market movements. Although price and momentum are open to individual interpretation, they are an investor’s best friend when it comes to understanding and deriving meaning from even the most basic chart.

So, what are the most useful charts to look at during this potential inflection point where the market either holds support levels or sinks another 8-15%? 

To that end, I’ve developed a useful, reliable approach that I call the “Economic Modern Family” – more on that below. Other important market benchmarks, like junk bonds or the S&P 500 futures, also tell a story or, at the very least, can help you produce an “if this, then that” trading plan.

Conflicting opinions

Goldman Sachs says stocks have found a floor, predicting that the S&P 500 [SPX] will end the year at 4,300. Yesterday, it closed at 3,941.48. 

In contrast, Bank of America’s latest “flow show” was titled “3,600 is the new bull case.” Their analysts predict a potential move down to 3,000.

When bank analysts come out of their corners to spar with opposing opinions, we look for more evidence.

Will the S&P 500 continue to fall?

Beginning our evidence search with the S&P 500, the below SPX chart shows momentum, based on our Real Motion indicator, skimming along support (the dotted line) with a wee bit more work to do to prove recent lows at 3,805 can hold up. 

A move over 4,000 would confirm a temporary low in place, whereas a stagflation environment supports a trading range, rather than a bullish move much higher than about 4,400.

However, one must note that a break below 3,800 most likely means a move to 3,600 next. 

Junk bonds find support

Junk bonds [JNK] have been my favourite indicator to assess bottoms and tops. 

As of Tuesday, and after months of declines, JNK found interesting and critical support, as shown in the chart below. 

Junk bonds outperformed the SPX during Tuesday’s session. The chart also illustrates how junk bonds were first to falter at the end of 2021, long before stock indices. This makes Tuesday’s activity noteworthy.

Nonetheless, the bottom indicator – MarketGauge’s Triple Play indicator – is yet to confirm any real enthusiasm. Long bonds [TLT] are still outperforming high-yield, high-debt bonds. 

We need to see high-yield, high-debt bonds outperform the long bonds in order for the market to rally from here.

Meet the Economic Modern Family

My Economic Modern Family comprises one US index and five key economic sectors. Each offers a lot of information on both the health of the economy and the market. Let’s look at the first two constituents, shown in the chart below.

First, the small-cap Russell 2000 Index [IWM], made up of the smallest 2,000 stocks in the Russell 3000 Index, is my favourite index. Representing the industrial and manufacturing side of the economy, IWM is key to assessing the strength or weakness of the real economy. Currently, if IWM continues to fall in price, we see signs of stagflation and potential for recession. The momentum and price, although a bit off the lows, are not impressive.

Second, the S&P Retail ETF [XRT] is an exchange traded fund that represents the consumer in the US economy. Clearly, retail – both consumer discretionary and staples – tell an important story, as evidenced by recent declines in the share prices of cheaper stores like Costco [COST]. Price is freefalling, and the weak momentum suggests that stagflation, and perhaps a recession, are in the works.

The rest of my Economic Modern Family consists of transportation [IYT], semiconductors [SMH], biotechnology [IBB] and regional banks [KRE]. These indicators, shown in the charts below, provide further evidence of stagflation.

Interestingly biotechnology, on a relative basis, is the best performer of these four. However, momentum in all four sectors is anaemic. The consolidation of lower prices in semiconductors, transportation and regional banks likely means a new trading range is imminent. Biotechnology acts more agnostically because of its unique representation of both a cyclical and non-cyclical aspect of the economy. Simply put, we need our drugs – on both a seasonal basis and sometimes, as Covid proved, out of the blue. 

A plan of action

So, what is our “if that, then this” trading plan? If junk bonds hold up and yields rise again, that could be seen as a sign that bond traders believe we will escape recession and trade sideways-to-higher in the S&P 500, which could be expected to find resistance at 4,300-4,400. That would have a positive impact on all areas of the Economic Modern Family, though we would need to see the Russell 2000 act convincingly.

On the other hand, if yields continue to slip, junk bonds trade in a range and the SPX falls below 3,800, those momentum indicators, already weak in a bear market, could get a whole lot weaker. As could prices.

Mish Schneider is MarketGauge’s director of trading education and research. Read more of her market analysis here, or visit marketgauge.com.


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