The Retest is On
The past week has been a bit of a roller coaster ride in terms of investor emotions. The week began with hope as stocks rallied furiously on Monday in response to the White House suggesting the coming tariffs might be less harsh than market participants had expected. However, by the time Friday rolled around, disappointment and fear were back in a big way. And cutting to the chase, it looks like (well, to me, anyway) like a retest of the lows is "on."
Let's Review
To review, the current correction in the stock market began on the back of uncertainty relating to the expectations for the economy, inflation, the consumer, and, in turn, earnings. The thinking was straightforward. The administration's plans for revamping the economy are seen as inflationary. Perhaps very much so. And experienced investors know that higher inflation expectations tends to be bad for stock prices - for a myriad of reasons.
As a result, reports indicate that the fast-money hedge fund types decided to make a big change in their exposure to US equities - in a hurry. As we've discussed, CTAs and systematic trading shops went from the highest exposure to stocks in general (and AI Leading tech specifically) over the past 5 years to underweight equities. All in a few short weeks. My take is this "unwinding" of levered positions undoubtedly contributed to the quick flush lower.
The good news is that according to reports I've seen, the "unwind" has largely occurred. This helps explain why the market had taken on a somewhat calmer demeanor of late. Until Friday morning, anyway.
The Bounce Was Expected
With the S&P 500 hitting the magical -10% mark, sentiment having become extremely dour in response to the degree of downside volatility, and the "unwind" having occurred, I had opined that a bounce was likely in the near-term. After all, I know that Wall Street loves their historical trading analogs. And according to the Panic Playbook, a rebound was probably in the cards.
So, with some good news over last weekend (or perhaps more accurately, a lack of additional bad news), Monday's bounce wasn't exactly a surprise. The only question was how far the rebound would carry.
At times, the charts can be very helpful with this question. And this time around, I felt there was a very strong "target zone" for stocks to bounce into. You see, the S&P's 200 day moving average (seen by the press as a delineation between good and bad market environments, which, of course, oftentimes is a bit silly - but that's a story for another day) and one of the key Fibonacci retracement levels (0.382) were in the exact same spot. (See the chart below.)
S&P 500 Daily
View Full Size Chart
Thus, a bounce into this zone made perfect sense to me. As stocks moved into this area, the question then became, is it over? Are we heading higher from here? Or will the reasons behind the decline resurface?
Next Up: The Retest
As I've opined previously, the playbook tells us to expect two types of outcomes: Either a "V Bottom" or a more extended "Basing Period" which includes retesting the lows of the move - perhaps multiple times. In my experience, the key to which outcome is more likely is whether or not the "reason" for the decline has been resolved.
If the "issue" causing the fear in the market gets solved, stocks tend to quickly bounce higher - forming a "V" shape on the charts. But, if the issue lingers and uncertainty remains, then a longer period of back-and-forth (aka "price discovery") tends to occur.
What transpired after Monday tells us a lot from a technical perspective. First, there wasn't any follow-through after Monday's surge. Typically, you will see the rally continue for at least a couple days before it rests. But in this case, the rally immediately stalled on Tuesday, reversed on Wednesday, and has now completely failed as of Friday morning.
Why The Decline?
Friday's decline is being driven by news. Bad news. As in, very bad news - on the inflation front.
First, the Core PCE, which is the Fed's favorite measure of inflation, came in higher than expected. And then, perhaps more importantly, the Inflation Expectation component of the University of Michigan's survey of Consumer Sentiment came in at eye-popping levels. For the next 12 months, consumers say they expect inflation to run at 5.0% - versus 4.3% last month. And then the 5-year inflation expectation number came in at 4.1% vs 3.5% in February. These were very surprising, WELL ABOVE expectations as well as last month's readings.
The market's response was swift and unsurprising. Stocks went down, quickly. And bond yields actually fell, which is a sign of traders moving to safety. So... From my seat, it looks to me like the retest is "on." Advantage Bears.
As we've discussed, figuring out what happens next during the "retest" phase is more art than science. But with some bad fundamental news, I will not be surprised to see the market approach and perhaps even exceed the March 13th lows. As such, the next few weeks will be important.
But before you run out and bury your head in the sand, let's remember that consumer sentiment is being impacted right now in a very large way by political leanings. For example, if you are a Democrat, the sky is falling. Whereas, if you are a MAGA Republican, well, you get the idea.
Finally, let's keep in mind that earnings are expected to grow double digits to record highs this year. And from my perch, this alone ought to provide some support to the stock market at some point. Once everyone is done freaking out, that is.
Thought for the Day:
Without the dark, we'd never see the stars. -Unknown
Wishing you green screens and all the best for a great day,
David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research, a Registered Investment Advisor
Disclosures
At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.
NOT INDIVIDUAL INVESTMENT ADVICE. IMPORTANT FURTHER DISCLOSURES