The Factory Daily Letter
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How far will it spread?
In the last few years, we have all seen how a virus that first appears in a relatively contained manner in small part of the world can grow quietly at first – before becoming so widespread that there is little that can be done to stop it in the short term. The same phenomenon appears now to have taken over the equity markets and, so far, the antidotes readily to hand to mitigate it appear ineffective.
All the potential events and elements we have been discussing that have recently arisen and could potentially have stepped into support investor sentiment have so far proven only sufficiently supportive to bring very short bouts of relief to equities. Neither a “dovish” rate hike from the Fed, nor a drop in inflation on an annual basis, nor the excellent earnings results of companies that have recently reported Q1 results have been able to stem the bearish contagion: it seems like a wave of panic has been gradually taking over the market.
In today's daily, we will look at some of the charts on an assortment of the most emblematic stocks of the past few years to illustrate how this contagion has developed and gradually enveloped the large tech names. With index heavyweights such as Apple and Google breaking supports sentiment could be dampened further which, in this environment of lower liquidity, this could result in a new wave of volatility.
The origins of the contagion can be traced back to rising yields
Everything really began with a surge in bond yields, driven by record inflation which led to a fast repricing of the Fed’s rate-hiking trajectory. As illustrated below, since the beginning of the year, bond yields have broken above several key technical resistances that have triggered breakout contagion across several market pillars (as we will go on to detail below).
The US 10-year Treasury yield is now on the verge of breaking a 40-year resistance. In our view, this rally in yields looks over extended, giving the impression that the momentum could shortly run out of gas (one of the key components of our call for a rebound in equities in the near term). Nevertheless, the recent breakout (of the upper bound of the downtrend channel), while tentative, has already done some damage to the technical picture (thereby challenging our more optimistic stance). It has therefore prompted us to take a look at the technical condition of several market leaders for any clues as to the potential consequences of these recent technical events and what this might mean for the direction of the market:
The rising dollar has a hand in this too
On the currency side, the US dollar continues to play its role of safe-heaven asset. The currency has appreciated strongly, especially against the euro, the currency pair triggering a worrying breakout of the bottom band of a rising channel that dates back 40 years - in another sign of capitulation:
Which corners of the market caught it first?
Buzz and so-called “meme” stocks were the first victims, but this went (almost) unnoticed
Initially, the first victims were those stocks that were so popular with retail investors – they having risen sharply due to an aversion to institutional short selling on the part of smaller investors rallying on reddit and also investing their savings (and stimulus cheques) during the pandemic. Because of their obvious extreme rise without any fundamental value, these early cases of capitulation did not attract the attention of investors who expected that such behaviour would remain confined to such ‘casino’ stocks. The Buzz (or VanEck Social Sentiment) ETF seeks to track the BUZZ NextGen AI US Sentiment Leaders Index which is made up of those stocks attracting the most attention on online social media:
Super-spreaders: the more speculative pockets of the markets (such as non profitable tech) have now erased all of their pandemic gains
Initially, it was the more speculative Nasdaq stocks that seemed first to experience investor disinterest. The prospect of the Fed moving to normalize monetary policy suddenly made investors aware of the extreme valuations some stocks had reached in spite of their being at the very early stages of their existence - and whose future cash flow expectations were hard to predict.
One example of such a highly speculative stock is Peloton, which saw its stock price rise from 20 to 160 before reversing violently in a 90% fall from its peak:
Supposed disrupters have been disrupted
Having been such a darling of the pandemic off the back of the rapid digitalisation theme; ARK’s Fintech innovation fund has now fallen back to its March 2020 low:
Some stay-at-home winners have become back-to-life losers: falling back below their Covid-lows
The story is a little different for names like Netflix, corporates which took advantage of the pandemic to augment their already growing businesses. However, the combination of the reopening and changing monetary policy has resulted in their suffering an equally dramatic fall that in Netflix's case has sent the stock price below its pre-Covid lows:
Other high-beta pockets of the market have suffered but to a lesser extent. IPOs have moved below pre-Covid highs - but currently remain above their Covid lows
Among those names attracting attention at the beginning of 2021, newly quoted stocks seemed unstoppable. They were seen as embodying new trends and capable of taking market share quickly from established companies. However, and illustrated by the technical chart on the Renaissance IPO ETF below (that tracks the largest most liquid newly-listed US IPOs) began to consolidate in 2021, before the negative momentum started to accelerate as the price fell below 55. Today it is trading below its pre-Covid level.
The crypto-currency bubble may be bursting, which could hurt small investors further
Greyscale Bitcoin Trust is a well-known means by which smaller investors gain exposure to bitcoin without buying (and storing) it directly. It has had a bumpy ride:
From endemic to pandemic?
The chart below shows the MSCI World ex-USA since 2019. Following a top at around 34.6, the positive momentum has started to fade and the index tested its pre-COVID level during the first selloff in March. Then, the following relief rally failed to push the index back above the 200-day SMA and a second down move has pushed the index back to square one.
The key support to watch holds at 29, the 38.2% Fibonacci retracement of the full bullish sequence started in March 2020. A weekly close below this level would further deteriorate the technical outlook and pave the way for a decline towards 27.4 and 25.7, the 50% and 61.8% Fibonacci retracements of the prior bull run.
The ability for large tech to not cede to the panic is a key element for the S&P 500. They are showing the first symptoms but are yet to capitulate
Apple, which still is the largest-cap name in the S&P 500 (with a total weight of 6.8%) has made a worrying breakout of its 2-year rising channel. Adding to the negative picture, this breakout came after Apple achieved a full Elliot cycle which on a technical basis may open the door to more severe declines:
Amazon, the fourth-largest cap in the S&P 500 at 2.8%, has followed suit, breaking a 7-year support:
The infamous FAANG index may have reached a support relative to the S&P500. Some hope persists?
While Apple and Amazon have both broken key broke their supports, the FAAMNGs relative to the S&P500 (both equally weighted) has continue to hold support:
Volatility shows no signs of panic yet, another hopeful sign?
Despite the surge in realized volatility, climatic panic has been avoided so far. The VIX index has remained astonishingly quiet all things considered, but the trend has nevertheless been reverting since last year. Technically it is currently challenging a 2-year resistance that has managed to fend off a breakout several times recently - in those moments when we have seen the market rebound. A bearish divergence indicates that a pullback is more likely than a breakout.
Are defensive sectors immune? Could they save the market from capitulation?
Defensive names have been outperforming the market recently with staples forming a technical “head and shoulder” pattern. While most of the move might have been made, the ratio has recently crossed above a 4-year resistance level and is heading towards the “H&S” target at 88 which could imply future potential weakness:
Both the staples and utilities sector ETFs remain in positive uptrends, characterised by a series of higher lows:
In Europe, we continue to favour the Swiss equity market which could continue to outperform the German DAX:
Our call for bottom fishing in quality tech may have been premature
As we wrote earlier this week, tech stocks appear oversold on several indicators. Only 13.9% of the Nasdaq 100 are currently trading above their 200-day moving averages. While such an extreme level tends to indicate an imminent bottom, the breadth measure has gone lower - in 2018, and during the bear markets of 2002, 2008 and 2020. In this instance, short-term rebounds have been very limited, and the selling pressure has remained strong. While technology stocks continue to look oversold, the rebound we expected has not materialized:
Waiting for Godot?
As was the case with Covid, it appears the market requires a big trigger to shake up the sentiment. It was the discovery and approval of an effective Covid vaccine that proved the turning point for the market in 2020, but the extremely accommodative monetary policy provided fertile ground for risk taking; today, the policy (and geopolitical and growth) outlook is very different.
However, and as we have experienced in the past, solutions frequently surprise – and we continue to dream of a quick and peaceful end to the war in Ukraine, maintain that the Fed would ultimately prove more dovish than priced, and remain ever hopeful that a stronger than expected economy proves strong enough to withstand the policy and global supply challenges it is currently presented with.
In the meantime however, and as far as equity markets are concerned, a more defensive approach that favours utilities and staples might help limit the degree of downside suffered in the event of any larger drawdowns across the markets over the coming weeks should they materialize.
We will continue to seek out tactical long opportunities when and where conditions look extremely oversold and key technical support levels are being tested. But any such opportunities are in our view likely to remain very tactical in nature for the time being - and any such strategy designed to exploit what could prove a series of short-lived relief rallies. Lower levels of volatility and greater liquidity, combined with a stronger catalyst are necessary to attract flows and encourage medium-longer-term investors back to the stock market.
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