Last week one after another Fed officials stepped out making very hawkish statements about its plans to tighten monetary policies. The Fed telegraphed that they are going to raise rates and shrink balance sheet aggressively to combat inflation. This is the tightest monetary policy since 1994 if the Fed is able to execute it successfully. This unexpected extreme Fed hawkish statements did greater damage to the NASDAQ than the DOW index. The mood is risk averse and therefore the DOW is the leader among the big three indexes.
Underneath the indexes, Energy has been leading in 3-month and Healthcare sector has been leading in 1-month and 1-week relative performance against S&P 500, meaning that the bounce from March 14th low was led by defensive sector. Clearly the market had a transfer of leadership from Energy to Healthcare. This leadership transfer is a clear indication that the stock market is leading the economy into a contraction.
Below is the chart showing where the cyclical positions of the stock and economy are through sector leadership. The red line represents the stock market, the green line represents the economy. You can see that stock market leads economy. The current Healthcare leadership is pointing to the start of a bear stock market and a top in the economic cycle.
A stock market top can last 6-9 months before it breaks down, meaning the stock market can trade sideways with a slight bullish bias (propped up by the defensive blue chips stocks) before a serious selloff happens.
Inside the NASDAQ index, chip ETF SMH is grossly under performing. This further convinced us that the stock market is entering a bearish market with defensive sector such as Healthcare leading and the cyclicals such as semi-conductor is lagging.
Originally we thought the severely oversold growth stocks would bounce strongly along with the general stock market and rally into August-October seasonal high area and then enter a selloff season after the mid-term election. Semi-conductor (SMH), consumer discretionary (XLY) and tech (XLK) were leading the market bouncing from the March 14th low until March 29th, the daily cycle top. SMH, XLY and XLK were under performing defensive sectors during the daily cycle high to low phase with the help from the hawkish Fed officials. The Fed crashed the tech rally and ignited a rally in defensive stocks.
Now it looks like the non-indexed growth stocks will get hurt if the rotation to Healthcare continues. The mega tech stocks (Apple, Google and Microsoft) will still work in this challenging environment as the mega tech stocks are considered defensive as well.
With all things considered, we are not bearish immediately (difficult to short the market at this stage) after last week’s selloff since there are defensive sectors rallying to prop up the indexes. But we are fully aware that the market is entering the defensive last leg of the 4-year cycle. We believe the high oil prices will come down from here due to COVID lockdown in China and Strategic Petroleum Release. Also the hawkish Fed statements can exert some sort of mythical power on market/inflation psychology.
That being said about the small and big pictures, we will trade the TQQQ ETF along the way and will not get into any individual stocks, especially those are not included in any index. You could potentially sell covered calls against your long term hyper growth stock holdings. The hyper growth stocks will not perform in this environment, period.
Below is the daily NASDAQ chart. It is 19 days into the current daily cycle that started on March 15th. The Q1 earnings season starts next week. Hopefully the not so bad earnings season changes the hawkish Fed narrative next week and reverses last week’s selloff.
Last Friday, the DOW had a bullish day trading structure, S&P 500 had a neutral day trading structure while the NASDAQ was intraday bearish, but it was an inside day, indecisive.
Let’s see if the DOW can follow up with last Friday’s strength on Monday.
So if we do get some kind of rally next week, you should know the rallies are not reliable and will be choppy until tech can take leadership over Healthcare.