The Factory Daily Letter

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The technical view

In May, US stock market indices experienced a relief rally built on the idea that a spike in inflation and aggressive central bank policy could occur. This rebound allowed the S&P500 to narrowly avoid entering a bear market as it approached a 20% loss from its peak.

However, the release of April’s US CPI figures put a pin in the idea that the Fed may put a pause in its rate-hike trajectory as policymakers turned more hawkish and markets started to price a 75-basis point hike at the June meeting – a hike which the Fed duly delivered. And it was not just the Fed – the week witnessed a series of hikes from global central banks that even included a surprise 50 basis point hike from the SNB. Against this backdrop of accelerating monetary policy normalization, investor sentiment remains very depressed, with concerns evolving from inflation worries to recession fears. The Fed has also come under criticism for its apparent confidence that it can still engineer a soft landing while at the same time saying it has limited control over inflation, leading to the perception of a binary outcome whereby either economy breaks, or inflation slows, or both (while a report from the New York Fed out Friday put the probability of a soft landing at 10%...)

From a technical point of view, the US equity market outlook remains very challenging, and our short-term bullish position has proven premature as the S&P500 index has reached a new low.

Looking ahead, the trend indicators remain negative, which forces us to be cautious. However, and as we have discussed several times in recent weeks, the fear that is affecting investors is not new and much of the prevailing negative sentiment has already been incorporated into the price action. Signs of a possible relief rally from extreme pessimism and oversold conditions continue to keep hopes alive for some stabilisation.

Has the recent volatility been exacerbated by the quadruple witching?

It is possible that last week's volatility was exacerbated by technical events, such as the quarterly quadruple witching day, when multiple derivatives contracts expire at the same time, including stock index futures, stock index options, stock options, and single stock futures.

Quadruple witching dates occur four times a year on the third Friday of March, June, September, and December. Market activity on these days is typically highest during the last trading hour as traders try to move on these contracts. Increased activity is due to the options and futures contracts that are profitable (in-the-money) settling automatically with offsetting trades.

Historically, the average performance of the S&P500 since 2016 around quadruple witching (in blue in the chart below) shows that the index tends to fall in the previous 10 days, before the positive momentum tends to resume:

Source: FactSet; Pictet Trading Strategy; as of 20/6/2022.

Signs of capitulation:

After a period of sideways consolidation in late May, the negative momentum in US equities picked up with a vengeance on the release of the aforementioned US CPI figures. From a technical point of view, the S&P500 made three consecutive days with an opening gap down and ended near its low as bears took control from the bulls for three consecutive trading sessions. As we discussed last week, after three consecutive days of declines of more than 1%, the S&P500 historically tends to see positive performance after 6 months.

So is this the sign of capitulation that was missing before the index can finally form a local bottom?

Source: FactSet; Pictet Trading Strategy; as of 20/6/2022.

On the Nasdaq 100, the proportion of index members currently trading above their 200-day averages is now at lowest level since GFC

The chart below shows the percentage of Nasdaq 100 members trading above their respective 200-day SMAs. Usually this is an indicator of the overall market trend, but when this gauge has fallen below 20%, the market can be considered oversold and historically such lows have been consistent with market reversals. Currently, less than 8% of Nasdaq 100 stocks are trading above their 200-day SMAs, the lowest level since the GFC.

Source: FactSet; Pictet Trading Strategy; as of 20/6/2022.

A bullish signal from the Vix

Another short-term bullish signal that has emerged recently is that given by the Vix index, which has deviated more than 2 standard deviations from its 20-day moving average, before returning back inside that level. This type of price action has also in the past proven consistent with local bottoms on the S&P500:

Source: FactSet; Pictet Trading Strategy; as of 20/6/2022.

Are “smart” investors continuing to buy?

The latter part of last week was also marked by a positive divergence between the Dow Jones Industrial Average and the Smart Money Flow Index.

The Smart Money Flow Index is calculated by comparing the price action in the first 30 minutes of the trading session with the close. This is built on the premise that the beginning of the session is driven by the emotions of retail investors who tend to over-react to bad/good news. So-called “smart investors”, (professional investors who arguably have access to the best information available) tend to make their decisions at the close (after testing the market).

When the smart index diverges positively from the DJIA, then smart investors can be said to be repositioning themselves in the market and subsequently leading less-experienced investors into their convictions.

Source: FactSet; Pictet Trading Strategy; as of 20/6/2022.

Insider buying activity

Another indicator of the “smart” investor is the cumulative insider transaction index. The chart below shows that the 6-month cumulative insider buyers and sellers. The gauge has reached its highest level since 2018 (and you can see last week’s letter “What can we learn from the insiders” again here).

Source: FactSet; Pictet Trading Strategy; as of 20/6/2022.

Nasdaq 100: is the 200-week SMA, at 10,804 the last rampart?

The Nasdaq 100 index has historically found significant support between the 150 and 200-week moving averages. The last major low reached during the selloff was at 6,771, between the two gauges which were at 7,122 and 6,578, respectively. Many agree that these levels are something of a last bastion for the Nasdaq 100, and that a break of these supports could trigger a more pronounced decline:

Source: FactSet; Pictet Trading Strategy; as of 20/6/2022.

Oversold conditions combined with extreme pessimism still presents fertile ground for tactical investors

While our bullish scenario was invalidated by the break of the market’s former May low, extremely oversold markets and depressed sentiment continue to provide fertile ground for relief rallies. As we have shown, some of the technical factors are similar to the local bottom in May and a new relief rally could occur.

However, for a potential rally to be more substantial and turn into a bear market rally, a "fundamental" catalyst is needed. In the current environment, it is difficult to find such bullish factors, especially as market earnings expectations have remained relatively stable while recession risks and margin pressures seem to have increased. If sell-side analysts start to revise their earnings forecasts downwards, the theoretical arguments around cheap valuations will no longer be valid.

Among the factors that could fuel a rally, a further decline in WTI crude oil on recession fears could trigger a fall in 10-year yields and be seen as a positive (or less negative) factor for growth stocks such as the technology sectors.

Overall, the situation remains a difficult for long-term investors and a cautious approach is still warranted. On the other hand, and as we have been presenting in our recent letters, short-term tactical opportunities will nonetheless in our view continue to emerge and moreover may offer an attractive risk/reward ratio for investors able to implement close stop losses.

For this type of investor, we present below a screening of the most oversold stocks with the most positive insider activity and the most attractive distance to the consensus target price:

Source: FactSet; Markit, Copyright © 2022 S&P Global Market Intelligence; Pictet Trading Strategy; as of 21/6/2022. *Criteria are explained in the endnotes.

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