The market had its bounce in October and so far in November and SPY is back to its declining 200dma. Can we see some chasing and FOMO in December or will more selling follow? No one really knows. There are good arguments for both scenarios. I want to remain open-minded and trade the setups that show up instead of guessing the market direction.
Most breakouts have not been following through lately unless there is an immediate earnings catalyst. Such price behavior reveals a lack of urgency to own and chase in this market. In the meantime, some strong stocks have consistently accumulated on dips to potential support areas. The solar stock ENPH is a prime example. Every single breakout attempt has been met with fierce resistance, yet every pullback to its 10 or 20-day EMA has been scooped up.
My philosophy is that the market is forward-looking. It constantly tries to look 6-9 months ahead in the future and imagine what could happen. Take for example the price action in Zoom (ZM) – it has been declining for many months while its earnings and sales have been still impressive. Just now, we are starting to see a slowdown in their growth. The market anticipated that and acted accordingly. Price action has been a good leading indicator. Or take into account the market reaction in retailers this earnings season. The vast majority of them reported dismal numbers and yet, we saw rallies that seemed a bit counterintuitive. The market is seeing the potential for a recovery that is not reflected yet in those companies’ earnings. The former are forward-looking, and the latter are backward-looking. I rather trust price action than current earnings growth.
It seems the market is worrying about something different every week. Three weeks ago was about high inflation. Then after the lower-than-expected CPI print, about missing out on a potential rally. Last week, it seems the new worry was about the implications of a potential recession in 2023. We went from “bad news for the economy is good news for the stock market mantra” because it means the Fed might pivot earlier to “recession might not be fully priced in the stock market yet”. None of these things are relevant if you are a short-term trader.
Large caps QQQ and SPY tested their 10-day EMA and bounced. Small caps IWM tested their 20dEMA and bounced. It is normal to see some form of consolidation after the post-CPI ramp. The pullback in the past week has helped many stocks to form setups with better risk/reward entries. I see some intriguing setups in biotech and energy. That’s what matters. We don’t know if those setups are going to work but at least they exist. Most breakout attempts didn’t work last week, probably because of the general market weakness. Buying pullbacks have worked a lot better lately.
Financial markets strive to live in the future and anticipate events that haven’t happened yet. Last Thursday, the consumer inflation data came at the still-high 7.7% level but it was a little bit below mainstream estimates. This was enough to spark a rally of epic proportions, just like the one we saw in early summer. The rally that started in late June lasted until mid-August and brought some significant opportunities, especially among the most shorted names at the time. Are we currently experiencing something similar? After all, stocks tend to do well post-midterm elections. The market is betting again that the Fed will slow its rate increases. It is currently pricing a 50bps rate increase in December, not a 75bps. Will the market end up being wrong again in mid-December? Maybe, but there’s a long time until then and we can enjoy a rising market.
Let me make one thing crystal clear. I don’t have the illusion that the latest lift in stocks is anything more than just another bear market rally but that doesn’t mean that it can’t continue much longer than most expect and that you can’t make money in it. Bear market rallies are powerful and can lift all boats, not equally. The first stage is led by the most shorted and the worst-hit stocks. If there’s a second stage, the new leaders step up and outperform. The one drawback of the current push higher is that metals and other commodities are leading which means that inflation expectations will remain elevated and the Fed hawkish. The last FOMC meeting for the year is on Dec 14th. I suspect, most stocks will rally until then. Maybe, there could be a selloff in a week or so before it as some market participants will expect the Fed to remain on its current tightening warpath and take profits preemptively.