US equity markets have spent most of this year under pressure from the Federal Reserve’s battle with inflation, suffering a great deal of collateral damage as a result. This week investors will receive earnings data from several Wall Street giants, including Microsoft, Meta and Amazon. As much of the Fed’s tightening has been priced into the market, earnings will start to have a greater impact on future returns. If inflation really has peaked, the market is likely to return to a less hyper-correlated stance.
There are reasons to believe that the market’s inflation pain will soon abate. The chart below shows four data points: the S&P 500, the US Dollar Index, the US 30-year Treasury yield, and the Chicago Fed’s National Financial Conditions Index (NFCI). As the 30-year yield blasts higher and enters a parabolic posture (typical late in a trend), and the NFCI continues to highlight a tightening of financial conditions, we are seeing key divergences in the US Dollar index and S&P 500.
Investors prepare for possible tailwinds
The US dollar has been on a tear all year, as both a safe haven and a play on the Fed being more hawkish than its international counterparts. The dollar index’s failure to make new highs as 30-year yields rise and financial conditions tighten suggests that markets may be looking to an end of the risk-off environment as the Fed nears the end of its uber-hawkish stance.
With the S&P 500 above its 52-week low despite worsening economic conditions, equity investors appear to be positioning themselves for the end of peak tightening. That could bring positive tailwinds for equities.
Nasdaq-tracking QQQ set to rally?
The below chart of the Nasdaq-tracking Invesco QQQ Trust Series ETF [QQQ] shows that as equities begin to break away from bearish posturing in the debt market, internal stocks have formed bullish breadth divergences.
Firstly, the number of stocks below their 50- or 200-day moving averages has improved, despite the QQQ recently undercutting its June lows. Also, fewer stocks are hitting 52-week lows than in September and May. The possibility of peak yields means the bear market lows are in for interest rate-sensitive stocks, regardless of what general indexes do.
Having fallen below the June low before rebounding, the market is displaying a failed breakdown which has bullish implications. We have since broken the recent upper channel resistance and a bullish “follow through” day occurred last Friday. These macro and internal divergences, along with positive upside price reversals, indicate an upward bias for prices despite challenging macro conditions. The QQQ could rally a further 13% before encountering overhead resistance.
Meta may be poised to rebound
Turning to individual stocks, Facebook owner Meta Platforms [META] has been the clear tech underperformer in 2022. The stock has fallen more than 60% year to date, dropping to its lowest level since December 2018. This decline, along with a test of its lower channel line, sets up a potential asymmetric trade to the upside, despite the share price’s structural downtrend. Provided that Meta’s Q3 earnings – due out on 26 October – do not completely underwhelm, the shares are likely to lead upwards as positioning is one-sided and biased to the downside.
Amazon’s downtrend could be nearing its end
Amazon [AMZN] has displayed positive relative strength (RS) versus the S&P 500 – a feat it hasn’t achieved since the early months of the 2020 bull market. It is displaying what I call “A|B relative strength”, a measure which highlights how the market made lower lows and, at equivalent dates, AMZN made a higher low, indicating healthy buying despite the bear market.
A more technical RS calculation, my Caruso Adaptive Relative Strength (CARS) tool, suggests that AMZN is outperforming the S&P 500 on an absolute and volatility-adjusted basis. Of the leading tech firms, Amazon could be the first to break its downtrend.
Microsoft moving in line with the overall market
Microsoft [MSFT] has been moving in step with the Nasdaq 100 all year, with little difference in direction between the QQQ and MSFT. As Microsoft gets set to release its Q1 results later today, a significant surprise to the upside or downside could break that market linkage, generating potential trading opportunities in the direction of the surprise as investors price in the beat or miss.
Pricing is indicative. Past performance is not a reliable indicator of future results. The author's views and findings are his own and should not be relied upon as the basis of a trading or investment decision.