Traders and investors are braced for a difficult September and October. In 2020 and 2021, the Dow and the S&P 500 each fell sharply in September, despite making strong full-year gains in both of those years.
However, that view is a little short-termist. In 2017, 2018 and 2019, stocks rallied in September. Going further back, the picture is mixed. In US midterm election years since 1950, the Dow has fallen in 11 out of 18 pre-midterm Septembers.
Our expectation of a tough autumn is based not so much on historical precedent but on current global economic headwinds. Climate change is taking its toll, with droughts impacting crop yields and inland transportation in China, Europe and the US, while floods devastate Pakistan. Energy prices are skyrocketing as the war in Ukraine continues. Inflation is close to 40-year highs and looks set to remain at elevated levels for the foreseeable future. To combat high inflation, the US Federal Reserve is set to go on raising rates.
Further US rate rises spell stagflation
In the US, which is now in a technical recession after two successive quarters of GDP contraction, there was some hope among investors that the Fed might pivot on interest rates. However, those hopes were dealt a blow as Fed chair Jay Powell issued a hawkish address at Jackson Hole, saying that the Fed would “keep at it” on interest rates in a bid to tame rising prices. Markets now expect the Fed to raise rates by a further 0.75 percentage points in September.
Our take, based on nearly five decades of combined trading experience, is that stagflation will continue in the US. However, positive aspects of the American economy will keep the stock market from collapsing. For one, the US labour market is proving resilient. And despite high inflation, consumer confidence rose in July, surpassing market expectations. Furthermore, the US government has passed resolutions that could support infrastructure development and the uptake of electric vehicles.
With the above challenges and opportunities in mind, let’s take a closer look at four of the six key indicators that make up our ‘Economic Modern Family’. The index and three sector ETFs that we are about to examine not only capture the slowdown in momentum that we’re witnessing, they also offer insights in to where the US economy may be heading.
Transportation hits the brakes
First, let’s look at the iShares US Transportation ETF [IYT]. Having tested and failed the 200-day moving average (DMA) in mid-August, the price is heading towards the 50-DMA. After our expectations of a sell-off from resistance played out, we now wait to see if traders expect buying to come in at critical support. The Real Motion indicator, as shown in the lower portion of the chart below, illustrates declining momentum, suggesting that the jury is out on whether IYT can hold.
Russell 2000 remains above June lows
Second, the iShares Russell 2000 ETF [IWM], pictured on the right of the above image, is testing its 50-DMA. The Real Motion indicator shows that IWM, which continues to outperform the SPDR S&P 500 ETF Trust [SPY], is holding the 50- and 200-DMAs. Like transportation’s IYT, the small-cap IWM is showing signs of stress, but both ETFs are well above their June lows.
Retail seeks support
Third, the SPDR S&P Retail ETF [XRT] is also sitting on its 50-DMA. Momentum is declining, offering a further sign of weakening momentum. Like our other key indicators, XRT is under pressure and trying to establish a new support level in the trading range.
Finally, the Semiconductor ETF [SMH], pictured on the right of the above image, rounds out the picture. Well under the 50-DMA, SMH could find some support at around 210, but momentum has broken down. Since its peak in early August, SMH has underperformed relative to SPY.
In conclusion, perhaps what matters most right now is patience. Holding a large cash position could be the safest bet for traders and investors as we wait and see how the current situation plays out.
Mish’s ETF support and resistance levels
S&P 500 (SPY) Unconfirmed phase change to bearish, 400 pivotal
Russell 2000 (IWM) Held the 50-DMA and, if this continues, could see some buying
Dow (DIA) Unconfirmed phase change to bearish, 321 pivotal
Nasdaq (QQQ) Unconfirmed phase change to bearish, 305 pivotal
Regional Banks (KRE) 62.00 the 50-DMA
Semiconductors (SMH) Confirmed bear phase, but 215 pivotal support
Transportation (IYT) 227 the 50-DMA
Biotechnology (IBB) Confirmed bear phase, 124 resistance, 117 next support
Retail (XRT) 64.00 area the major 50-DMA support