A timeless bear market rule explains why dip buyers can't get a break: Morning Brief
27 May 2022
It's no secret that stocks and the 401(k)s that hold them have been battered and bruised this year, as every fledgling rally eventually whipsaws investors further into the red.
Last week, the S&P 500 (^GSPC) nearly closed 20% down from its record high — threatening to plaster 'bear market' headlines across the evening news. But the S&P avoiding this label is little comfort to many investors, as the Nasdaq has been in bear market territory since crossing this chasm on March 7.
In this market environment, it seems everything moves up or down, with these swings changing on a day-to-day, or sometimes minute-to-minute, basis. This is not market leadership.
Bob Farrell — one of the O.G. gods of technical analysis — explains why this dynamic is such a problem for any bulls still out there. Spelling it out in rule seven of his famous 10 rules of investing, Farrell said: "Markets are strongest when they are broad and weakest when they narrow to a handful of blue chip names."
And narrow leadership is where we found the market roughly six months ago.
Despite the S&P 500 minting a 28% total return last year, problems were surfacing under the hood.
The following chart from Bank of America technical research strategist Stephen Suttmeier, CFA, CMT shows the New York Stock Exchange advance-decline line. This line serves as a measure of market internals, or what's going on underneath the surface of the index. It shows how broad, or narrow, participation is in the market at a given point in time.
Signals like a deteriorating advance-decline line can grow and persist for long periods of time — frustrating both bulls and bears.
As we see in Suttmeier's chart, the S&P 500's rally that started in Q4 2020 finally stalled out and went sideways throughout most of 2021. This rally then broke to the downside in January of this year, retested the breakdown level, and travelled south to present levels.
A textbook example of a market that lacked solid leadership. And now, the damage suffered by the biggest stocks in the market can no longer be concealed.
Last week, Walmart (WMT) and Target (TGT) earnings revealed the big box retailers suffering from margin pressure and rising inventories, news that spooked the broader markets amid concerns over inflation and consumer spending.
The five biggest losers by market cap — Apple (AAPL), Tesla (TSLA), Alphabet (GOOGL), Walmart and Microsoft (MSFT) — shed a cool half a trillion dollars in market capitalization last week alone. Year-to-date, this group's losses total some $2.2 trillion.
"The breadth of the market is important," Suttmeier writes.
"Broad-based rallies have the potential to continue, while narrowing rallies are prone to failure. A market rally driven by a handful of blue chip names suggests that the [small- and mid-cap] troops have abandoned the largest cap generals, which is a weak setup for market breadth."
At the beginning of the year, a buy-the-dip that had worked since the pandemic lows was the sell-side's favorite trade. But now, we're in a different economic and market regime — with soaring inflation, an increasingly hawkish Fed, shellshocked consumers, the list goes on — and buy-the-dip doesn't work anymore.
So, what to do now? Investors may be best-served playing defense, waiting for the bullish signals to mount. To be sure, these signals are adding up, but we may need a final capitulation to reach this cycle's ultimate lows.
How painful that event may be remains the market's greatest unknown.
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