Friday, January 20, 2023
The S&P 500 kicked off 2023 with a solid start, moving the year-to-date return chains to over 4% last week before giving up some yardage over the previous few sessions (the index is still up 1.6% as of January 19). Oversold conditions, China’s reopening progress, and signs of cooling inflation in the U.S. primarily underpinned the buying pressure. However, receding inflation fears have quickly been replaced by rising recession fears. Disappointing retail sales and an underwhelming start to the fourth-quarter earnings season have recently contributed to the hard landing narrative, pouring some cold water on the rally in U.S. equity markets.
The S&P 500 has now found itself in a fourth-down situation with a major downtrend hovering overhead. Investors have seen this play before, as the index failed to surpass this resistance line several times throughout 2022. Will the S&P 500 go for it again and finally convert on fourth down? For the non-football fans, a conversion means a team gains enough yards on the play to capture the first down marker, which is essential to moving an offensive drive forward.
As a Minnesota Vikings fan, going for it on fourth down makes me nervous, especially after how our season ended this year. However, the technical evidence suggests the S&P 500 may have better luck, as the index is in better field position to convert on fourth down compared to prior attempts made in 2022. The chart below breaks down our thesis based on recent price action, momentum, and market breadth.
- The S&P 500 registered a higher low in December 2022, marking the first significant higher low after a retest of the downtrend. The S&P 500 also witnessed a peak-to-trough drawdown last year of 25.4%, in line with average bear market drawdowns that exclude recessions.
- Momentum remains bullish but not overbought. The Moving Average Convergence/Divergence (MACD) indicator is trending higher in an early-stage buy position, compared to generally overbought MACD readings during prior attempts at reversing the downtrend.
- Participation in the recovery from the October lows is expanding. The percentage of S&P 500 stocks trading above their 200-day moving average (dma) recently reached its highest level in twelve months.
- Furthermore, the cumulative Advance-Decline (AD) line for the NYSE, a broader measure of market breadth, recently reversed a downtrend and recaptured the 200-dma. The AD line was trending lower during the previous S&P 500 attempts at reversing its downtrend.
Macro field conditions have also improved over the last year. As shown in the chart below, the S&P 500’s previous downtrend reversal attempts were subject to a backdrop of sharply rising interest rates and a parabolic rally in the dollar. These headwinds have largely subsided, as both the 10-year Treasury yield and the U.S. Dollar index have violated uptrends. In addition, the backdrop for inflation has changed over the last year, evidenced by a recent peak in headline YoY CPI estimates for 2023. Cooling inflation data has also shifted market expectations for a peak terminal federal funds rate this spring and provided much needed visibility into the Federal Reserve’s monetary policy playbook.
In summary, while we remain respectful of the current downtrend on the S&P 500, the collective technical evidence suggests the index is in a better field position for a trend reversal than last year. Buying pressure at higher lows, bullish momentum, and broadening participation in the recovery should continue to support the current drive off the October lows. Falling and/or stabilizing interest rates, a weaker dollar, and the potential end to the Federal Reserve’s rate hike cycle also provides a more constructive backdrop for the development of a market bottom. Of course, disappointing earnings, sticky inflation, and increased recession risk could bring the defense back on the field. But for now, we suspect a first down for the S&P 500 is likely over the coming weeks, defined by a close above 4,000 which would finally break the current downtrend resistance line and recapture the 200-dma. A close above the December highs at 4,100 would then confirm a new uptrend is underway.
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