Good economic news, but the market is mostly sideways … two reasons we’ve been stuck in neutral … when our Strategic Trader experts see the bullishness resuming
In recent weeks, investors have received positive economic news that usually would push markets higher.
So, why haven’t the large-cap indexes really gone anywhere?
That’s the gist of the question that our technical analysts, John Jagerson and Wade Hansen, tackled in their latest issue of Strategic Trader.
In today’s Digest, let’s find out their answer.
As importantly, let’s discover how long these experts believe stocks will be stuck in neutral.
Let’s get right into it.
***If things are good, why are we trading sideways?
For newer Digest readers, John and Wade are the experts behind Strategic Trader. It’s an elite options service in which they combine insightful technical and fundamental analysis with market history, to take advantage of all sorts of market conditions.
To identify profitable trade set-ups, they analyze a variety of data points, ratios, and chart patterns. This information helps provide clues about where the market and specific stocks are likely headed.
In their update from Wednesday, John and Wade turned their analysis to why markets haven’t risen much in recent weeks, despite what appear to be supportive data.
Here they are, beginning with the good news that would seem to support market gains:
According to Zacks Research, of the 70% of the S&P 500 that have already reported earnings, profits are up 49%, and revenues have jumped 10.6%.
This shouldn’t be surprising when compared to market conditions in the first quarter of 2020. However, even when compared to pre-pandemic trends, growth is solid and is approaching records.
Factset also shows that average estimates for the second quarter are at their highest since the first quarter of 2018. These expectations are the second-highest since 2002.
In addition, expectations are high because the tone of the outlook for earnings has been extremely positive this season.
With all that good news, why haven’t the major large-cap indexes made any progress since mid-April?
To make sure we’re all on the same page, let’s see exactly what John and Wade are referencing.
We’ll start with the Dow, which has performed the best in recent weeks.
As you can see below, since April 19th, the Dow is up 1.5%. Notice that most of these gains have come in the last two days.
Moving on to the S&P, it’s up just 1%.
The Nasdaq brings up the rear. It’s down 1.7%
So… if this earnings season has been so strong, why aren’t stocks continuing their upward march?
Taking the question one step further, is this sideways action a precursor to a larger market correction? If not, when will things kick back into gear?
Here’s John and Wade:
We feel that there is minimal risk that the market will drop significantly in the short term. However, two significant factors could extend this “pause” for a few more weeks while traders wait for more data.
Let’s see what these significant factors are.
***Inflation fears have traders acting cautiously
From the Strategic Trader update:
We have addressed concerns about inflation in nearly every weekly update since stimulus checks first started going out last year. Yes, the Fed is using unprecedented levels of quantitative easing, and direct stimulus payments from the U.S. Treasury could be inflationary.
What appears to be making traders nervous is the future threat of inflation, not something that is happening right now.
Investors tend to “overprice” the unknown, which leads us to believe that market volatility related to this issue is itself inflated.
Now, is there a way we can pinpoint volatility related to inflation concerns, compared to broad market volatility? We need to ask this question since any number of issues could be leading to market jitters.
John and Wade suggest we look at “TIPS”:
The following chart below shows the yield on special bonds the Treasury issues that protect against inflation.
These Treasury Inflation-Protected Securities (TIPS) have a yield that will fall when inflation is expected.
(NOTE: remember the inverse relationship between yields and prices. A falling yield means prices are rising – in other words, there’s demand for the asset, which is pushing the price higher. In this case, there’s demand for TIPS, which are designed to protect against inflation.)
As you can see, investors are pricing these as they did in 2013.
Fig. 1 – 10-Year Treasury Inflation-Indexed Security – Chart Source: Board of Governors of the Federal Reserve System
Two things to highlight about this chart, beyond the levels that John and Wade just pointed out.
The first is how yields have been dropping since November 2019 – this is the broader trend.
Second, notice how the recent, upward reversal in trend has changed course. Since March 18th, yields have resumed their broad trend, downward trajectory.
You can see this easier in the chart below, which zeroes in on 2021.
Back to John and Wade:
An appropriate question at this point is whether this pricing has been accurate in the past?
The short answer is mostly no.
Inflation, excluding food and energy prices, has remained trapped within a reasonably tight range around 2% for the last 20 years.
Because we believe inflation poses minimal short-term risks, the market is likely to continue rising once these concerns die down a little.
However, there are enough long-term warnings for potential inflation to keep our strategy flexible as more data is released.
So, long-term, John and Wade have their eye on inflation. But for now, they believe this inflation-related sideways market action will be short-lived.
What about the second factor weighing on the major indexes?
***Profit-taking has been a headwind to additional market gains
Back to John and Wade:
A pattern that emerges in bull markets is for consolidations to occur once the market has rallied 161% of its prior drawdown. We attribute this cycle to normal profit-taking and rebalancing.
As you can see in the following chart below, the market recently reached that technical level following the 2020 drawdown.
This level also lines up with a similar short-term analysis based on the March 2021 drawdown.
Fig. 2 – S&P 500 (2 day periods) – Chart Source: TradingView
While it’s comforting to learn there’s a technical precedent for stocks taking a breather after such a long climb, let’s turn to the logical question…
How much longer will it last?
From the Strategic Trader update:
Technical pauses like this are expected. Based on prior consolidations, we should probably plan for this holding pattern to last for another 3-6 weeks.
While this doesn’t change our bullish outlook, we can use the data to set timing expectations for the next breakout.
I’ll add that John’s and Wade’s options-selling service doesn’t need a bullish market environment to generate cash. This type of sideways market can be similarly profitable. If you’d like to learn more about how it works, click here.
Wrapping up, this stuck-in-neutral market isn’t fun to sit through, but such consolidations are a normal part of investing. Fortunately, if John and Wade are right, the major indexes will be kicking back into gear soon enough.
We’ll continue to keep you updated here in the Digest.
Have a good evening,