U.S Stocks: Following the CPI Print, the S&P 500, Nasdaq100, and Dow Jones

Oct 13, 2022
VOT Research Desk

Market Insights and Analysis

On this morning’s run, the Nasdaq100 made a new two-year low, while the Dow fell from a crucial region of resistance that was mentioned in this week’s forecast. The S&P 500 made a quick run at the 3500 level, which was my first support target on the index considered in the Q4 Top Trades, setting a new yearly low. The following link can be used to see the whole Top Trades report:

Given the recent volatility in markets, retail traders are probably pretty well aware of that, and for traders in equity or equity-related markets, that has been a very obvious lesson over the past nine months.

The world became addicted to cheap money 12 years after the global financial collapse as a result of massive stimulus from global central banks. Despite globalization’s apparent unraveling as the year progresses, natural resources remained inexpensive. Markets rose for years thanks to cheap money, and after a long enough period of time, it almost seems as though central banks forgot about the possibility of inflation.

They dismissed inflation whenever it did occur until it reached intolerable levels of more than 6% annualized. They started to change their course around that time, but it took another four months for the first rate hike to take place after Powell “retired” the word “transitory” in March.

Additionally, bad habits are hard to break. Markets continue to search for a glimmer of hope that they might return to their previous ways despite the Fed’s fairly explicit message that inflation is the priority. It’s almost ironic that the Fed wants to price out markets with the same optimism, enthusiasm, and bullish behavior (in order to bring inflation back to target).

We received the most recent version of this story this morning. It stated that Core CPI reached a new high of 6.6%, surpassing the previous high of 6.5%, which was announced in March. After that earlier spike, Center CPI went lower – by 6.2% in April and 5.9% in June. The expectation that inflation had reached its peak grew. In July, a print of 5.9% was released, but in August (which was released in September), Core CPI printed at 6.3%.

It came in at 6.6% this morning to set a new record and firmly deny that inflation had reached its peak. The immediate response was brutal, resulting in a support break in US stocks, with the S&P 500 making a new annual low and the Nasdaq100 making a new two-year low.

S&P 500 The S&P 500 futures had not yet tested the trough of last week prior to this morning’s CPI reading. On the weekly chart, the price movement from the previous week also produced an inverted hammer formation, which provided potential for a bounce until the bottom was refuted this morning.  

The bigger trend still favors the bearish side, as I noted in the forecast, and given the fundamentals, there was little reason to expect a larger-picture turnaround.

Having said that, the first sentence of this article comes into play: Trends do not develop in a linear fashion. Although the overall situation has been bearish for some time, there still appears to be a “buy the dip” mentality based on the hope that the Federal Reserve will alter its stance regarding the fight against inflation.

This would be similar to, but less so than, the theme that emerged in mid-June, immediately following the Fed’s first 75bp rate hike, which led to a stock market rally that lasted for two months.

That was stepped on in August, and Chair Powell pounced on it later that month at Jackson Hole with a message that was shorter and more concise, stating that the Fed was not finished with rate hikes. However, even after the price had fallen to new lows, sellers slowed their approach, and bearish breakouts have not continued. Even this morning, just prior to the CPI report, that June swing low at 3659 was in play.

Analytics

That 3659 level in the S&P 500? Yes, that is the 38.2% retracement of a significant Fibonacci retracement, calculated from the low in 2016 to the high in January. Even after the Fed raised interest rates by 75 basis points and warned that more were on the way, that helped to halt the declines in June. Since a support break occurred, bears have struggled steadily below that level, and we are rapidly approaching the following level on the chart.

Now, let’s talk about the near future, which I went into detail about in this week’s equity forecast: We don’t think we have yet seen widespread surrender. Yields typically decrease in tandem with a falling market as investors prepare for more challenging terrain. Because investors can lock in higher rates before yields fall further, bonds are an appealing alternative because falling yields can also raise the principal value of those bonds. As a result, bonds can be traded for principal gain just like stocks if yields are actually falling.

That is not present here. There is nowhere to hide as bond and stock prices fall. As a result, we believe that many investors in long-term equity have merely rode the wave for the time being. Put-call ratios show that sentiment in the short term has been and will continue to be strongly bearish.

And sentiment is important because it can slow down declines because a market with a lot of short positions leaves few investors willing, able, and ready to sell, especially if the long-term capitulation factor is not present.

This morning may be a good illustration of that: a negative market item makes a quick and strong breakout, but short-term bears cover positions after the fact, causing the breakout to fade.

Does this indicate that the sell-off is over or that it has reached a support barrier? No, but it does indicate that, like any other trend, this one will not be linear, despite the fact that the fundamental background appears to be linear.

We can narrow in on a few other noteworthy zones from the Weekly S&P 500 chart. Around 3500, which coincides with the 3491 Fibonacci level, is my next down support. After that, the pre-pandemic swing high of 3400 comes into play, making up 50% of the pandemic move.

Below that, there is a Fibonacci reference in the 3300 and 3200 ranges, and if there is a capitulation factor, there is even a reference on the chart in the 2800 range. As of this writing, that zone is approximately 21 percent away from the current price. While this may seem like a far-fetched possibility, if the Fed’s tightening does break something and panic enters the equation, it may be closer than we had anticipated.

Indices Fibonacci Pivot Points (Daily)