Skip to main content
  • Stocks largely shrugged off this week's rate hikes and poor GDP report.
  • The rally has lifted the indexes back into resistance.
  • Active investors should protect recent gains by moving up their stop losses.

This week’s economic calendar was packed with potential land mines. First, on Wednesday, the Fed announced its second consecutive 0.75% increase to the Fed Funds rate (sorry, borrowers!), and Chair Powell said more rates are coming. Then, on Thursday, the BEA announced that GDP fell 0.9%, marking the second consecutive decline in U.S. economic activity. And on Friday, the headline 6.8% Personal Consumption Expenditure (PCE) data shows inflation remains rampant.

You’d think all that “bad” news would have meant a steady string of down days. But instead, the major stock indexes largely shrugged. After the Fed’s report, stocks rallied on the assumption that business as usual would set the stage for a friendlier Fed next year. Investors were similarly unsurprised by the negative GDP print.

The ability for stocks to shrug off bad news is an encouraging character change, but there’s reason to believe that we’re not out of the woods yet. The major indexes' rally since June has lifted them into resistance. Working through trapped investors eager to get out flat could mean more sellers emerge in August, a month that’s notoriously a poor performer. According to the Stock Trader’s Almanac, the S&P 500 and NASDAQ average return in August during mid-term election years is -0.2% and -1.2%, respectively, over the past 50 years. Moreover, August ranks as the 10th and 11th worst month of the year for those indexes, respectively.

Watch your head

After a big move, the ceiling where resistance lives is rapidly approaching. You could wind up bruised if stocks hit that resistance and turn lower if you're not careful.

In her latest market note, Top Stocks technical expert Helene Meisler highlights intriguing cross currents, such as improving internals and a market that’s become overbought on her advance/decline oscillator. She writes:

“On a positive note, let me report that the number of new highs expanded today. Nasdaq has the most since April. And the New York Stock Exchange's McClellan Summation Index crossed over the zero-line for the first time since January.”

That’s all well and good, but Meisler also observes that despite the run-up, investors remain skeptical. If the market stumbles, they could have itchy trigger fingers. According to Meisler:

“I really thought sentiment would turn by now. In fact, I am surprised that the chatter is more bullish than the statistics. Maybe, very surprised.

Today’s put/call ratio was the lowest we’ve seen since July 15, and it was .94. In all the other rallies we’ve seen, folks jump on the bandwagon quickly, but this time there is strong reluctance. Perhaps they are buying stocks, covering shorts, and buying puts, but whatever it is, they are not embracing the rally using call options.

But it’s not just the options ratios; the National Association of Active Investment Managers folks, who would have been surveyed on their exposure on Wednesday morning have barely budged with their exposure at 42.”

Indeed, this rally may be driven by short covering, like most rallies during bear markets. The NAAIM data suggests institutional investors are reluctant to ramp purchases given the summer doldrums and the steady drumbeat of worrisome economic data. The still high put/call ratio suggests faster-acting hedge funds (and momentum-oriented computer programs) may have bought some stocks to ride on the back of short covering, but they’re still using puts to control risk in case they’re wrong.

Yes, investor ‘skepticism’ can be a good thing over time because stocks like to climb walls of worry, but how much higher we climb may depend on how stocks digest approaching resistance levels.

Back to Meisler:

“We are now short-term overbought. My own Oscillator is overbought since eight of the last 10 trading days, the breadth has been positive. This means we are about to drop a long string of positive numbers.

Way back in June, when I warmed up to the market, one of the charts I showed was this channel in the Dow Jones industrial average. It’s been choppy until this last week or so, but it is finally making its way to the top of the channel, around 33,000. That also happens to be the high area (resistance) from the June high. It, therefore, makes sense for an overbought market to have a pause from resistance.”

You can see what Meisler’s referring to in the following chart. Note how she’s connected three prior peaks to draw the upper downtrend and how that line intersects at her 33,000 target. Currently, we’re at the upper end of this channel, and as you can see in the chart, failures at the upper end have preceded sharp retreats back toward the lower end of it. Nobody knows what happens here, but the risk of retreating from resistance is probably why so many investors are gunshy.

CHART_0729

The Smart Play

It’s been a nice run-up, but there are some reasons to tap the brake pedal. First, it can take big money managers a few days to digest data, so this sugar high may not be sustainable. Second, stocks don’t rise or fall in a straight line, so it wouldn’t be shocking to see, at a minimum, a bit of backfilling. Finally, remember, historically, the next two months are poor performers.

For these reasons, active investors should move up stops to protect their recent gains. You can be more relaxed about using stop losses in an established bull market supported by a friendly Fed and a strong economy. However, that’s not the environment we find ourselves in today.

Stocks remain in a bear market, and the Fed’s laser-focused on slowing the economy to curb inflation. Friday’s PCE’s headline number was the biggest year-over-year change in inflation since 1982. Also, the less volatile core inflation figure, which removes energy and food, ticked up, not down, in June. Core PCE increased 0.6% in June, its biggest jump since April 2021, and its 4.8% year-over-year increase was up slightly from last month’s 4.7% reading, despite all the tightening this year.

Eventually, prices will anniversary big increases in the fourth and first quarter, but until then, real wages remain under pressure. In short, Friday’s inflation data doesn’t yet support the argument that the Fed’s likely to back away from being hawkish. For example, the odds of a 0.75% rate increase in September increased to 36% this morning from 26% yesterday. As a result, make sure you protect yourself in case stocks retreat.

THUMB-Bear-Killer-JS-092322 (1)

Stocks: Will October Be Another Bear Killer?

October delivers historically strong returns during mid-term election years and bear markets.

THUMB-Oversold-Market-JS-092222

Is The Stock Market Getting Oversold?

A sharp sell-off this month has many oversold indicators suggesting a bear market rally is increasingly likely.

THUMB-Federal-Reserve-Stocks-JS-092122

The Federal Reserve Remains Stocks’ Enemy

The Federal Reserve increased interest rates by another 0.75% today, stiffening the headwind for stocks.

Stocks: Will October Be Another "Bear Killer?"

Stocks: Will October Be Another Bear Killer?

October delivers historically strong returns during mid-term election years and bear markets.

THUMB-Oversold-Market-JS-092222

Is The Stock Market Getting Oversold?

A sharp sell-off this month has many oversold indicators suggesting a bear market rally is increasingly likely.

THUMB-Federal-Reserve-Stocks-JS-092122

The Federal Reserve Remains Stocks’ Enemy

The Federal Reserve increased interest rates by another 0.75% today, stiffening the headwind for stocks.

THUMB-Housing-Stocks-JS-092022

It’s Still Too Soon To Buy Housing Stocks

Housing-related stocks have been punished this year, but surging inventory and dwindling demand mean they're still too risky to buy.