Stocks Turn It Over In the Redzone in August

We hope you have a good holiday weekend!

The S&P 500 declined -3.29% this week with Friday's close at 3,924.26. The index has now declined three weeks in a row, falling -8.31% in the process.

The high of this week came on Monday (4,062.99), the low of the week came on Thursday (3,903.65), and the index found selling pressure almost every single day this week. For example, Monday closed -0.80% off its high, Tuesday and Wednesday closed -1.45% and -1.50% off their daily highs too, respectively. Thursday then saw the opposite as participants "bought the dip" with the S&P 500 closing 1.62% above its daily low, but Friday then gave it all back! If "they" bought the dip on Friday, then "they" sold the rip on Friday, with the index closing -2.34% off its daily high. If Thursday and Friday represented a wrestling match between eager buyers and sellers, then the sellers won this week.

In last week's Update we wrote:

"If the index can bend but not break, implying the index trades down into the 3,900s during the week but finishes the week back over the 4,000 marker, that would be a fairly encouraging sign."

We were encouraged on Friday morning when the index traded up above the 4,000 marker, especially after trading down to 3,903.65 on Thursday morning. It appeared the index was bending but not breaking, buoyed higher by Friday's jobs report (click here). But Friday's selloff, which seemed to be sparked by this headline (click here), left us finishing the week slightly discouraged. Good thing feelings have no place in the forecasting and investment decision-making process...

Looking at the charts, the S&P 500 is now below any and all widely followed moving averages. Further, Friday's selloff actually originated from a backtest of the 50-day simple moving average (50MA) which stood at the ~4,020 region. The market makes the news, so we can't help but wonder if it was actually the backtest of the 50MA that led to emerging selling pressure on Friday, and not the headline out of Russia.

Regardless, about the only good things we can mention right now are Friday's selloff didn't see the S&P 500 break down below Thursday's low, Friday saw a late-day move higher from the 3,906.21 level (a few points above Thursday's low at 3,903.65), and this week's lows are right at the Fibonacci 61.8% retracement level. The "bear market rally" reversed in the vicinity of the 61.8% retracement level when connecting January's all-time highs to June lows, which was ~4,367. Maybe the "correction" following Powell's unexpectedly "hawkish" stance at Jackson Hole will also reverse at the 61.8% retracement level when connecting June's low to August's high, which stands at 3,900.76. Leonardo Fibonacci is smiling up there (click here).

The selloff the last three weeks does sort of leave the index in no-man's-land. We have a top (or "resistance") at 4,325.28 and we have a bottom (or "support") at 3,636.87.

The trillion-dollar question is which level does the S&P 500 reach first, 3,636.87 or 4,325.28? A retest of June's low or a retest of August's high? Nobody truly knows for sure, but it feels like the S&P 500 has been turned "off"...

We've written a lot over the years about how modern markets have developed a tendency to trade like they have an "on/off" switch, and the price action since the June low illustrates the point well. Three weeks ago the S&P 500 was on a three-week winning streak that gained 8.03% over the trailing three weeks. Now? The S&P 500 is on a three-week losing streak and has lost -8.31% over the last three weeks. It's as though seven weeks ago the index was turned "on" and four weeks ago the index was turned "off".

Since 1950, there are only five other instances of the S&P 500 recording a three-week losing streak that declined -5% or more immediately after recording a three-week winning streak that gained 5% or more. Interestingly, we've now seen this pattern occur twice in 2022, with the other five dates being:

4/22/2022

7/3/2009

9/13/2002

8/6/1999

8/17/1973

If we change the criteria to identify all instances of the S&P 500 recording a three-week losing streak that declined -5% or more immediately after gaining 5% or more over the prior three-week period (i.e., it doesn't have to occur over a three-week winning streak), we still only find nine prior instances of this happening. In other words, strength typically precedes strength, and it's rare to see what we've just seen, which is the S&P 500 follow the strength of a gaining 5% or more over a three-week period with the weakness of a three-week losing streak that falls an equivalent amount on the downside in percentage terms (-5%).

As we mentioned, this is now the second time in 2022 the S&P 500 has recorded this six-week pattern. The price action following the last occurrence on 4/22/2022 was downright nasty. If we're experiencing a case of deja vu, the answer to the trillion- dollar question will be a retest of ~3,636. That's still a big "if" though, and it's not necessarily a bad thing! "Double bottoms" are always possible.

All eleven sectors within the S&P 500 finished in the red this week, and we can't recall the last time that happened.

Utilities were the top performing sector, only falling -1.47%. Technology was the worst performing sector, falling -5.03%.

As for the week ahead, we have a holiday-shortened trading week on our hands with the markets closed on Monday. We've also got a light week ahead on the economic data and market-moving news front. We continue to believe that the inflation story holds all the cards as it's the single biggest determinant of Fed policy. We'll get inflation data on 9/13, and on 9/21 the Federal Reserve will hike interest rates and Fed Chair Powell will get another opportunity to speak to the markets. Something tells us that's where he's likely to "pivot", especially if 9/13's inflation data shows a sequential month-over-month decline in the Consumer Price Index (something we think is likely). So, the price action this week will be somewhat telling as participants attempt to discount what's coming on the 13th.

S&P 500 Primary Trend - Down

The S&P 500 finished the month of August on Wednesday, falling -4.24% with a monthly close at 3,955.

The index fell flat on its face the final two weeks of the month, turning what was a 4.72% monthly gain at the highs of the month on Tuesday, August 16, into a -4.24% monthly loss. We haven't seen a monthly reversal like this since March of 2020, and February of 2020 before that.

In our Update from August 14 we wrote:

"But, it's not the end of August yet! Remember, monthly closing prices won't go official until August 31st, 13 trading days away. Thirteen trading days are an eternity for the S&P 500, especially when the Volatility Index (VIX) is hovering near 20. This too supports why we believe the remainder of August is so pivotal. If "they" don't sell 'em we're likely staring at our 12th "2 & 10% Price Thrust Reversal". If they do sell 'em, then the picture will become decidedly more uncertain."

Unfortunately, we didn't come close to recording a "2 & 10% Price Thrust Reversal". "They" sold 'em like mad these last few weeks and that's why the picture is now decidedly more uncertain.

The S&P 500 will need to find a way to close a calendar month back above its 12-month simple moving average before we can even theorize about the "bear market" being over.

We wrote last week about September's seasonality and how it's traditionally a poor performing month for the S&P 500. Well, all Septembers are not created equal! Sometimes the S&P 500 enters the month of September having been on a tear higher for the year, and other times it limps into September licking its wounds on a year-to-date basis. The year 2022 is clearly the latter.

The S&P 500 finished the month of August down by more than -10% for the year.

The table below lists all other calendar years since 1950 where the S&P 500 finished August down -10% or more. Historically speaking, this has tended to be associated with absolutely wild months of September. Each of the last four Septembers saw the S&P 500 decline at least -8.17%, which is shocking to write.

Of course, what happened in each of the above prior calendar years has no bearing on what will happen here in 2022.

But, the ingredients are clearly there for a crazy September and the table above is almost nothing but crazy Septembers. So, the seat belt light remains on.

As we've written all year, at least since the end of January, we believe long-term investors are best served investing more conservatively than they otherwise would if the primary trend for the S&P 500 was labeled as up or "bullish".

The forecast is cloudy with a chance of torrential downpour, massive thunder, and jaw-dropping lightning. It's anything but the sunny skies that dominated all of 2021. Therefore, if you're doing the same thing you were doing in 2021 and expecting the same results, that's not going to work.

We recognize that it's all but guaranteed that the sunny skies will return and the best of times do lie ahead for markets, but we openly admit we have no idea when that will be. Given that degree of uncertainty, and the consequences of passively investing during primary downtrends, or "bear markets", we believe long-term investors should manage the risk of getting stuck outside in torrential downpour. We believe strategy diversification is an answer. Strategic and tactical asset allocation strategies can sit at the same dinner table and have a grand old time (h/t Manish Khatta).

In the world of long-term investing, risk is all that's guaranteed, returns are only expected.

Therefore, all we can control are the risks we're willing to accept, and philosophically speaking, it feels negligent for an investor to be taking the same degree of risk today that they did in 2021. If the seat belt light is on, we believe you should wear your seat belt!

Bonds Remain Dead, Commodities Get Hit, VIX Snoozes

Random happenings across the investable universe this week:

The bond market remains broken. The Dow Jones Corporate Bond Index (DJCB) declined -1.95% this week and has now fallen three weeks in a row. While DJCB is still above its intraday lows from June, this week's close was a fresh new 52-week low close. We're not sure of the "why" behind the recent selloff across the bond market, especially given the "peak inflation" narrative, but there's a chance for a "double bottom" here if DJCB can find support here and now.

The Reuters/Jeffries CRB Index (CRB), a broad-based measure of commodity prices, fell -4.59% this week. Unlike the bond market, this jives with the "peak inflation" narrative, which only furthers the mystery behind the recent bond market rout.

CRB continues to consolidate after a gigantic move higher since 2020. CRB should go as inflation expectations go, so this will continue to be a chart worth watching.

One of the more perplexing aspects of this week's selloff was the fact that the Volatility Index (VIX) actually declined on the week, the same week where the S&P 500 declined -3%+! That's definitely not the norm.

We haven't seen this happen since February of 2009, but the VIX was in the mid-40s at that time. The last time we saw the VIX sleep through a week where the S&P 500 declined -3% or more (meaning the VIX finished the same week red and closed below the 30 level) was March of 2003. And before that was August of 2001...

From a narrative perspective, we interpret the pairing of falling stock prices with the lack of a VIX spike as a relatively bad omen. If participants aren't rushing for protection via opening put option contracts and/or selling covered calls, all while stock prices are falling, it would seem that participants are more interested in liquidating their underlying securities rather than hedging their underlying securities. That's not exactly a vote of confidence regarding what lies ahead for those underlying securities.

It will be interesting to see if we get some sort of VIX spike over the weeks ahead. "Bear markets" have a way of producing outliers that catch market participants off guard, and that's usually enough to ignite the demand for protection. Time will tell!

Happy Sunday!

Steve & Rick

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