Finally, a stronger week … what our technical experts are watching now … a bullish bias, but keep your eyes on these two red flags

It’s a Friday, so per recent tradition, we’re going to check in with our technical experts, John Jagerson and Wade Hansen.

For the last two weeks, they’ve been guiding us through this painful tech correction, helping us maintain a correct perspective and focus.

It hasn’t always been easy — on Monday, the Nasdaq officially fell into correction territory. Yet, Tuesday through Thursday saw strong gains for all three major indices, providing investors a much-needed breather.

At Thursday’s close, both the S&P and the Dow had notched new record-highs. Meanwhile, the beleaguered Nasdaq capped a strong 3-day rally, climbing 6.3% from its Monday-lows.

As I write Friday morning, the selling pressure on tech has returned thanks to an uptick in the 10-Year Treasury yield. The Nasdaq is off about 1%. However, the Dow is up 0.5% and the S&P is basically flat.

All-in-all, it’s been a week we can celebrate. On that note, here’s John and Wade:

The bounce on Tuesday that started at a short-term support level on the S&P 500 looks like the kind of bounce that could send prices back above the prior highs again …

As discussed in our last Weekly Update, we feel that investors should look at short-term dips as buying opportunities.

So, where does this leave us today?

Is the market-weakness over, and it’s back to a succession of new highs? Or is today’s weakness in the Nasdaq a hint at more volatility to come?

Today, we’ll find out what our technical experts think.

Let’s jump in.

 

***The market finds technical support propped up by transportation stocks

For newer Digest readers, John and Wade are the experts behind Strategic Trader. It’s an options service in which they combine insightful technical and fundamental analysis, with market history, to take advantage of all sorts of market conditions.

Fortunately, those market conditions are improving today …

Let’s turn to John’s and Wade’s Wednesday update:

As you can see in the following chart, the S&P 500 hit 3,745, which is roughly equal to the bottom after January’s dip. And it has been rising since then as investors begin to favor risky assets again.

Transportation stocks were an important piece of evidence that we pointed to last week, and they have remained defensive during the pullback.

Historically, a defensive transportation sector has preceded a shorter correction, which is likely to be the case this time.

 

Fig. 1 — Comparison Chart of S&P 500 Index & Transportation Sector — Chart Source: TradingView

For any readers who are unaware, transportation stocks often are seen as a leading indicator of where the broader market will go.

The idea is that when the economy is healthy, businesses will ship more product throughout the nation. The converse is also believed to be true. So, monitoring the performance of transportation stocks acts as a sort of crystal ball for the broader economy and, by extension, the market.

***What about the source of recent pain in so many investor portfolios … tech

Back to John and Wade:

From a technical perspective, the bounce in the tech sector, including the stay-at-home stocks like Chegg (CHGG), is especially encouraging.

We have been convinced that tech was oversold almost from the beginning of the correction. In fact, as you can see in the next chart, the relative performance between the dominant SPDR Technology ETF (XLK) and the S&P 500 had reached a multi-month low.

 

Fig. 2 — Relative Strength Chart of SPDR Technology ETF vs. S&P 500 Index — Chart Source: TradingView

John and Wade explain that relative strength compares the price performance of one security or index (tech) with another by turning them into a ratio.

On Monday, this tech/S&P ratio broke below its short-term historical range.

Back to John and Wade for what this means:

… (this) may have been one of the triggers for investors to jump back into some of the best-performing stocks over the last year, while prices were “cheap” on a relative basis.

As noted earlier, tech has continued to rebound this week. As you can see below, even with today’s weakness, it’s still up 2.7% on the week, and up roughly 5% from its Monday-low.

 

 

***What’s the outlook going forward?

John and Wade write that even though they see market activity pointing to higher highs in the short term, they still recommend trading very cautiously. Two factors have them on edge.

From their update:

First, the 10-year yield is above resistance of 1.5%. If growth expectations are the key driver for higher rates, then we shouldn’t be worried.

However, sentiment is split about this issue. There are other indicators in the bond market pointing at inflation expectations as the real problem driving rates, which would result in falling prices.

It’s a little too early to know for sure which is correct, but we’ll keep you posted.

I’ll add that we received encouraging inflation news Wednesday.

First, the Bureau of Labor Statistics’ Consumer Price Index (“CPI”) reading for February posted a gain of 0.4%, on a month-over-month basis. That was in line with expectations. But more importantly, the core data gained just 0.1%. That was weaker than anticipated.

On an annualized basis, overall CPI increased 1.7%, which also was in line with analysts’ estimates. The best news was that the core data only climbed 1.3%, coming in below the anticipated 1.4%.

Investors — primarily tech investors — have been worried about a spike in inflation. If rates climb too high, it makes borrowing costs too expensive for tech companies (many of them are cash-strapped), which threatens to hamper growth.

But these data suggest such a spike isn’t here yet. It may come, but for now, there’s nothing here to derail the market.

That said, a rising 10-Year yield is spooking tech investors Friday.

It ticked higher overnight, and is trading at recent highs as I write (1.626%).

 

Keep your eye on this 10-Year yield. Where it goes will have significant implications for stocks.

***What’s John’s and Wade’s second concern today?

Back to their update:

… the international economic outlook is still very uncertain. It is unlikely that the U.S. will be able to sustain current growth levels if China, Japan and Europe aren’t moving in the same direction.

An imperfect but useful proxy for economic growth are stock indexes. As you can see in the following chart, the Japanese Nikkei 225 and German DAX30 are both looking fine.

However, the drop in the Shanghai Composite has only accelerated since the correction began.

 

Fig. 3 — Comparison Chart of Shanghai Comp., Nikkei 225, DAX30 & S&P 500 — Chart Source: TradingView

 

This is not a red flag yet, but it is an issue we will be tracking.

Prior to the COVID-19 pandemic crash in 2020, a decline in the Chinese indexes was a good predictor for whether U.S. markets were likely to follow.

I’ll add that since the Strategic Trader update, the Shangai has enjoyed a strong, upward reversal, as you can see below.

 

This is good news for the health of global markets. We’ll continue to keep an eye on it.

Wrapping up, despite the Nasdaq’s Friday weakness, we have to be pleased with this week. We’ve hit new highs in the S&P and the Dow, and we saw renewed strength in tech.

John and Wade believe markets will continue to climb, but keep your eye on the 10-Year yield and China. If things go off the rails there, expect more downward pressure on stocks.

Here are John and Wade to take us out:

We plan to maintain a bullish bias for now. Valuations are very high, but we think this is more likely to cause volatility than a sharp decline.

This is essentially what the market has been doing the last three months, so we don’t expect to change our strategy yet.

Have a good evening,

Jeff Remsburg