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  • The conditions are ripe for a relief rally.
  • The stock market could rally 10%
  • The duration of the rally depends on how investors react to bad news.

Looking at weekly closing prices on the major indexes wouldn’t make you feel very bullish. For example, the S&P 500, NASDAQ composite, and Russell 2000 fell 2.4%, 2.8%, and 2.6%, respectively, last week.

Dig into the day-to-day performance, however, and you feel more confident.

Stocks have been taking cues from the direction of Treasury bonds all year, selling off as yields have rallied. However, that relationship came temporarily unmoored last week. 

The yield on the 10-year reversed lower intraday on May 9 as investors flocked to safety, and after peaking near 3.12%, it was back below 3% on the 10th. Instead of rallying right away, though, it took a few days before stocks found their footing, mounting a sharp reversal higher during Thursday's final hour of trading.

The stock market’s strength continued with the S&P 500, NASDAQ composite, and Russell 2000 gaining 2.4%, 3.8%, and 3%, respectively, on Friday. The strength was so widespread that Friday was the first 90% upside day since June 2020 (upside volume was 90% or more of the total up and down volume). You can learn more about 90% days in this Lowry’s report, but it can be (isn’t always!) a bullish indicator following 90% down days (we had a 94% down day last Monday and a 94% down day on May 5th).

A steep decline in stocks (the S&P 500 flirted with bear market territory last week) and horrible sentiment (elevated put/call ratio, VIX, and bearish responses to sentiment surveys), and lower Treasury yields primed the pump for a rally, but will this rally have any legs?

How long will a rally last?

In “My Review of Indicators Points the Way to a Tradable Rally,” Real Money technical expert Bruce Kamich reviews charts of the major markets, concluding “This is not "THE Low" in my opinion, but it represents a turn where we can make some money on the long side for a few weeks before renewed declines.”

The best bull markets are built on top of solid foundations. Those foundations look like bases, comprising sideways trading characterized by a series of pops and drops that shake out sellers trapped at higher prices.

This isn’t like that. Instead, Kamich thinks we’ll experience a deeply oversold rally that could run for a bit before eventually stalling (i.e., it could be one of the many pops and drops necessary for building base).

Kamich’s opinion reflects a bit of a tide shift given his bearish outlook for most of the stocks he looks at daily for Real Money. So, the fact he’s spotting some technical green shoots is intriguing. Kamich writes:

“Since our Dec. 9 review/forecast for 2022 we consistently have been pretty negative on the stock market averages and a host of individual names. Buy recommendations from me have been few and far between, but now the patterns suggest a recovery rally that should be a worthwhile trade. This is not a buy-and-hold recommendation. Remember that in a few weeks when the upside gains begin to slow.”

Kamich’s short-term bullishness is partly based on his take on the S&P 500.

“In this daily Japanese candlestick chart of SPDR S&P 500 ETF ( SPY), below, we can see a potential bottom reversal in the past three days. Prices are deeply oversold when looking at the slow stochastic indicator in the bottom panel. The trading volume has been heavy in the first half of May, suggesting some degree of "throw in the towel" selling. However, the daily On-Balance-Volume (OBV) line has not made a new low with the price action for a bullish divergence.”


How far does Kamich think the market could rally? About 10%, but only if the market’s reaction to bad news is positive. 

Kamich’s third guideline in his book, How Technical Analysis Works” is “Don’t Expect Too Much.” If you begin extrapolating riches from a relief rally, you're gambling, not investing. Let the price action dictate bullishness or bearishness, not hope.

Back to Kamich:

“The story above is not what is interesting, but what will be interesting is if the stock market ignores this kind of "news."... Treat each trade as just a trade. Don't talk yourself into finding the next stock that will climb tenfold and allow you to retire. This kind of thinking is not productive…Treat this recommendation as a trade looking for a 10% move on the upside. For the next few weeks, the news will remain bearish, but stock prices will probably rise. Pay attention to the price action, not the news.”

The Smart Play

Kamich isn’t the only technician thinking we could get an actionable rally. Top Stocks’ Helene Meisler’s been analyzing charts for decades, and her indicators also support some upside. 

In “How Long Will the Rally Last?,” Meisler writes, “We may very well come back down on Monday, but that won’t change the fact that this past week some of the intermediate-term indicators got oversold, and that should mean we rally for longer than a day and a half.”

Meisler notes the volume indicator reading was 42% (oversold), the NASDAQ Hi-Lo Indicator was 0.02 (oversold), and the 30-day moving average of the advance/decline line was also oversold.

The big takeaway is that technically speaking, there’s been a lot of damage done to stocks, and since stocks don’t fall in a straight line (they staircase up and down), we’re due for some upside. However, the amount of upside and the duration of upside are questionable.

The Martin Zweig Fed Indicator remains bearish, and there’s been zero chatter suggesting a change of heart at the Fed regarding tightening. Inflation is stubbornly high and weighs consumer confidence and spending, meaning a recession is on the table (stocks tend to bottom before a recession ends, though).

Also, there’s still plenty of risk to earnings because of higher input costs. Over 90% of the S&P 500 has reported first-quarter earnings (retailers start reporting results in mass this week), and analysts are increasingly modeling for less profit (inflation) despite higher revenue (inflation surcharges failing to cover rising input costs). According to Real Money’s Stephen Guilfoyle:

“Analysts look for margin pressures to be the talk of the second quarter as the consensus for Q2 earnings growth has now dropped to 4.4% from 4.8% last week and 5.5% the week before last week. This, while expectations for Q2 revenue growth have expanded slightly from 9.8% to 9.9%.”

The risks are a reminder not to confuse “a” bottom with “the” bottom. Bear markets often have multiple bottoms that are actionable and, unfortunately, short-lived. The current market is different from 2008/09 and 2020 because the Fed is unfriendly, so odds favor caution over fearlessness.

As a result, worry less about maximizing return by market timing broken, beaten-up early cycle stocks and more about risk control. There will be plenty of profit in early-cycle stocks once we’ve built bases and the Fed’s friendly again. So instead, focus on defensive stocks that can still benefit from a rising S&P 500 like consumer goods, utilities, and healthcare and low-beta, dividend-paying value stocks.

If you're an active investor and early cycle stocks are too alluring, stick with best-in-breed names you won’t mind owning if the market rolls over, use stop losses to contain risk, be quick, and don’t overcommit (keep plenty of cash). You’re more likely to strike out than hit a home run if you swing for the fence. That may be OK here and there, but ultimately, your win rate and portfolio balance will suffer if you aren't careful.

If you’re a long-term investor, stick with the plan. Increasing the amount you’re dollar-cost averaging into an index during a bear market is a great way to profit once bulls are back in control. Remember, the average bear market lasts about ten months, and on average, the market recoups its losses in about 14 months. However, that’s untrue for individual stocks. Many individual stocks may not recover prior peaks for years (or decades), if at all, so if you’re buying individual stocks, focus on the business cycle trade and top stocks.

  • The conditions are ripe for a relief rally.
  • The stock market could rally 10%
  • The duration of the rally depends on how investors react to bad news.

Looking at weekly closing prices on the major indexes wouldn’t make you feel very bullish. For example, the S&P 500, NASDAQ composite, and Russell 2000 fell 2.4%, 2.8%, and 2.6%, respectively, last week.

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