The S&P 500 declined -1.20% this week with Friday's close at 4,108.54.
Trading was fairly quiet this holiday-shortened week with the weekly high-low range recording at just ~2.49%, the narrowest range since early April. The index traded as high as 4,177.51 on Thursday and appeared to be headed toward the ~4,200 region, but Friday's price action had other ideas.
We wrote last week that "If the index can manage to hold on to everything it gained this week, we'll consider that a win", so we do find the price action this week slightly disappointing.
There's a theory in technical analysis that suggests that old levels of support (blue arrow on the chart below), once broken, morph into new levels of resistance (red shaded region). The daily chart of the S&P 500 exemplifies that at the moment with this week's downside reversal (i.e., resistance) coming from the 4,176 level, right next to what was once the upside reversal (i.e., support) at the 4,170 level.
While the lack of follow-through this week was slightly disappointing, we do still believe in what we wrote two weeks ago: the S&P 500 will work its way back toward the ~4,200-4,300 region over the weeks ahead (ideally next week!).
Admittedly, there isn't much science behind this. Our thesis is mostly just that when the S&P 500 takes six gigantic steps backward it usually then takes three gigantic steps forward before potentially heading even further backward. Such a 50% retracement would leave the index trading around the ~4,265 level. We think that's an inevitability here in June...
As for market internals, there was a lot of talk about "breadth thrust" last week given the move to the upside, but this week was more of a breadth bust. Tuesday and Wednesday saw just 104 and 94 constituents within the S&P 500 advance on the session. Thursday was impressive with 433 stocks within the S&P 500 closing green but Friday was then the opposite, finishing the week on a sour note, with just 71 of the S&P 500's holdings advancing on the day. Collectively, that's a four-day average of daily advancers of ~176. At the end of last week there was a legitimate chance at a Whaley 10-day two-to-one breadth thrust (click here) if there was follow-through to the upside this past week, but the bulls turned the ball over in the red zone the last five days.
In terms of sectors, there were only two in the green this week, energy and the industrials. Energy was the top performing sector, gaining 1.11% for the week, and is now higher by an insane 62.82% thus far in 2022. The worst performing sectors were real estate and health care, both of which declined more than -2% on the week. Sector dispersion thus far in 2022 remains gigantic. Three sectors are down in "bear market" territory (technology -19.34%, communications -23.05%, consumer discretionary -25.05%) while three sectors remain at and around all-time highs (energy +62.82%, utilities +4.56%, consumer staples -3.83%). All stocks, and sectors, are not created equal here in 2022.
S&P 500 Primary Trend - Down
The S&P 500 finished the month of May on Tuesday, closing the month unchanged, rising by 0.01% and closing at 4,132.15. Our work continues to label the primary trend as down, or "bearish".
During downtrends, long-term investors are best served pairing together an equity underweight with more active investing methodologies. The name of the game during downtrends is simply to survive, with survive being defined as striving to lose as little money as possible. It isn't until the primary trend is up, or "bullish", that long-term investors can go back to doing what worked in 2021.
So "sell in May and go away" is now behind us and the S&P 500 finished the month of May down -13.30% for the year thus far. Since 1950, that's the third worst start to a year though May's close behind the 1970 and 1962 declines of -16.85% and -16.66% respectively. The index also closed the month of May with negative trailing 3-, 6-, and 12-month returns, a hallmark of a decided downtrend.
Since 1950, this marks just the 11th May to finish this way, with the most recent instance being 2002. In all 10 prior instances, the S&P 500's average returns over the forward 3, 4, and 5 months is negative with win rates at 50% or less across all time periods mentioned. In the world of stocks, strength tends to beget strength and weakness tends to beget weakness. We're already nervous about the third quarter.
Whether our nervousness is misplaced would seem to lie in whether or not the U.S. economy does indeed head into recession here in 2022. That will probably determine whether the S&P 500's bottom in May at the 3,810 region is actually thee bottom.
There are a myriad of ways to identify market-based probabilities of recession, but one that stands out to us is the relative performance of consumer discretionary stocks (CDS) vs. consumer staple stocks (CSS).
The relative outperformance of CDS vs. CSS is the old adage of consuming wants vs. needs. Wants, by definition, are discretionary expenses. They represent a form of consumption that's elective and therefore economically sensitive. During recessionary climates, consumers tend to reduce their spending on wants. CDS are companies like Amazon, Tesla and Nike. Each of these companies' underlying profitability is a derivative of consumers "wanting" their product. We certainly don't need Air Jordans.
Needs, by definition, are the exact opposite. They're not discretionary expenses, they're expenses for everything we all need in our day-to-day lives. Needs represent a form of consumption that's not elective and therefore isn't economically sensitive. Consumers are going to consume their needs regardless of whether the economy is growing or contracting. CSS are companies like Procter & Gamble, Coca-Cola and Philip Morris.
If we chart the ratio of CDS (as measured by the SPDR Consumer Discretionary Select Sector ETF, ticker XLY) to CSS (as measured by the SPDR Consumer Staples Select Sector ETF, ticker XLP), we can identify which sector is outperforming. The sector that's outperforming then becomes the market's preferred sector, which in turn reveals the market's forward-looking expectations for the economy. When XLY is outpacing XLP, market participants clearly aren't pricing in a recessionary climate forward-looking. Alternatively, when XLP is outpacing XLY, market participants may be pricing in a recessionary climate forward-looking.
Referencing the chart, XLP has been absolutely trouncing XLY over the last year. XLP has outpaced XLY by 24.74% the last twelve months as of Friday's close.
This becomes ominous as XLP has outpaced XLY by 20% or more only a few other times since their inception...the years 2000 and 2007.
Each of the last two times we've seen this happen the economy did indeed head into recession, forward- looking, and the S&P 500 was mired in a prolonged downtrend.
Now, it's important that we note this is something that's only happened two other times in last 20+ years and there is nothing we can truly take away from just two instances. As an example, you might hit two consecutive half-court shots at your local basketball court, but that most certainly doesn't "predict" you becoming the next Stephen Curry.
However, this can and should be used to help long-term investors avoid complacency. There exists a possibility of the S&P 500 trading down another -20%, or even -30%, before truly finding a lasting bottom. Behaving with your portfolio as if this can't happen, as if this time absolutely will "be different", is the epitome of complacency.
Remember, the price of the S&P 500 has an uncanny ability to trade beyond the limits of imagination. The tails are fat on both sides. Respect uncertainty, remain dispassionate and stick to your long-term investing plan.
Happy Sunday!
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