The Stock Market Hesitates at Important Resistance Just Before FED Meeting
Various financial markets will be focused this week on the February 1st, meeting of the Federal Reserve Board. This comes on the heels of an unusual number of other central banks conducting meetings. The meeting itself and the commentary come at a critical inflection point for the stock market.
The markets since the turn of the year have been enthusiastic, even while the economy suffers and is widely expected to slide into recession. That seems a bit odd, but it continues to be the game of “bad news is good news” because bad news will supposedly cause the FED to pause and then start to lower interest rates once again. The stock market in particular seems betting on a “soft landing” and a pivot in interest rate policy.
Why the market has such faith that the 600 or so PhDs running the FED can engineer a soft landing after the same geniuses so badly misplayed inflation, is indeed a wonder. But the FED over the past 20 years has quickly injected liquidity and lowered interest rates when the economy and/or the markets stumble. So, a whole generation of traders has grown up to expect this behavior.
This creates a dilemma for the FED. They have been trying to talk inflation down, including asset inflation, and soaring markets make their job more difficult. Maybe that is the ironic payback the FED gets for training the markets to jump around like puppies seeking a treat. How do they pivot without once again creating the asset bubble they are seeking to deflate?
There are additional hopes that China’s reopening after its extensive and brutal Covid lockdown, will also cause that economy to revive and help pull the world out of its stupor. Chinese stock indexes have been rising sharply.
In the US, just after the opening on Monday, the S&P index is up 5.3% so far in this very new year. The more value-laden Dow Industrials are up 2.5%, and the more speculative and tech-rich NASDAQ Composite is up 9.3%.
The aggregate bond index AGG is up 3%, after last year’s brutal pounding. The Commodity Index is flat.
Gold is up 5.65%, beating the S&P by a slight margin while GDX, which represents gold mining stocks is up 12%. Silver is down 1.75%.
The general stock market is banging on the door of what technical types call overhead resistance. After making a series of declining peaks over the past year or so of decline, the tops can be joined to form a trendline. Many traders also watch the 200-day moving average. The S&P basically is right at the resistance of the bear market linear trendline and the 200-day moving average, so a good response to the mid-week FED meeting (and auxiliary FED statements) will come at a critical technical level for the market. Stocks will either break through or fail again at this resistance.
The market last week was slightly above the linear trend, above the 200-day moving average and the 50-day moving average is about to cross the 200-day moving average creating what is called a “golden cross.”
A number of indices also display golden crosses. This is also regarded by technical mavens as a sign of market strength.
So regardless of what one’s preconceptions are about the economy, and your opinion about stocks should be doing, the stock market since the turn of the year has been strong and is now barking at the door of a decent breakout to the upside.
But, we will just have to see if that breakout occurs or if we fail again at resistance.
One negative related factor is that sentiment studies show the market is too enthusiastic. Without getting too deep into the technical weeds, when everyone gets enthusiastic, that attitude gets translated into action, and hence current prices already reflect that positive view. Various studies including the CNN Fear and Greed gauge now show the market view solidly in the greed range. The CNN Fear and Greed reading is compiled using about a half dozen indicators measuring investor attitude.
The gauge has moved to 68 and was just 37 one month ago, which shows just how quickly opinions can change. Readings over 75 are considered extreme greed.
That does not necessarily negate completely the chance of a break out to the upside for the market, but history suggests that when sentiment is already this hot, breakouts don’t carry that much further upward because excessive optimism is already in the price structure.
Like most investors, we have been enjoying the recovery in prices. However, with sentiment already hot and a recession still the most likely outcome, investors should consider caution and temper their confidence. While objectively we have been getting a market advance, the question is: is it sustainable or is it just a bear market rally?
Buying more equities would work if it is the former, but would be disastrous if it turns out to be the latter.
This week will certainly provide us much needed additional information.
*** The graph included in this article is courtesy of stockcharts.com