Market Analysis: SPY Performance

In this post, I will give a market analysis focusing on the current status of the S&P 500 ETF (SPY).

As you can see in the chart above, SPY broke out above the exponential moving average ribbon (yellow and orange) lines. Increased volume confirmed the breakout. The ribbon continues to narrow which also confirms the breakout. Moving averages converge during the consolidation phase prior to a breakout. However, there are quite a few signs that are still bearish.

First, the VIX is at the bottom of its trend line and both the daily and weekly oscillators for the VIX are ready to move back up. This creates a strong directional bias toward greater volatility in the coming days and weeks.

Second, another headwind for the SPY is that we are heading into a bearish part of the year: August and September. Look at the below seasonality chart for August and September.

Third, due to extreme bearishness, market participants have begun to respond extremely bullishly to any news with a glimmer of hope, even when the news is largely bad. For example, today the Fed indicated that it would hike interest rates another 75 basis points (continuing an historic rate of change) and then, in September, start to accelerate the roll-off of assets from its balance sheet. In a normal context, the market would crash on such news, but today it rallied strongly. Even though these Fed actions will, to a very high degree of certainty, cause a recession, in the interim these actions will quell inflation, which is the market's present concern.

Few market participants have seemed to notice that the Federal Reserve has been reducing money supply at a significant rate both through direct means and through more obfuscated means. This creates a near technical impossibility for risk assets to explode higher at the previous bull rally speed.

However, there are definitely positive signs as well. After all, markets typically rise the fastest at the end of the economic cycle (after the yield curve inverts) and as the Fed signals a pivot to less tightening. Indeed, the monthly oscillators on the SPY are ready to move back up creating a directional bias for SPY to go higher in the coming months. In July, it has been steadily putting in higher highs.

More often than not, when the K line crosses above the D line on the Stochastic RSI oscillator while it is in oversold territory, the following months experience a rally. However, there are quite a few false positives of this indicator, especially in the context of a recession.

There are some important Fibonacci levels that are also acting as support. For more on SPY Fibonacci levels, you can view my prior post below:

Finally, I would be remiss not to show one last important S&P 500 chart that some may find disturbing: The yearly Stochastic RSI of the S&P 500 (see below)

This ominous chart shows that 2021 was sitting right at the top of an overextended yearly Stochastic RSI and 2022 began the process of oscillating down. In the 150 years of S&P 500 data that produced this chart, a rapid descent from this high level of over-extension has only occurred five times before. In the best scenario, the stock market only managed to go up 50% in the decade during which the oscillator corrected downward. In another case, the stock market was roughly flat for a decade (rising less than 10% for the entire decade). The other two cases were the 2000-2002 Dot Com bust and the Great Depression.

Interestingly, just last month we bounced off the third Fibonacci spiral from the peak of the Great Depression.

Perhaps this is a mere coincidence, or perhaps we'll have a mild recession like we did at the second Fibonacci spiral from the Great Depression (the recession of the early 1990s), or perhaps we are beginning a new supercycle characterized by low economic growth, recessions and stagflation.

Only time will tell.

I'm curious to hear thoughts and counter-arguments, so please feel free to comment below (but please be polite).

Comment:

In the section about the yearly Stochastic RSI, I meant to say this has only happened 4 times before over the past 150 years (this event, if it unfolds, is incredibly rare). So far 2022 appears to be the start of the 5th oscillation down for the S&P 500 yearly chart. However, I would be quite surprised if the Fed doesn't try to force this oscillator back up as they did in 2020, which resulted in a double top. The big concern though is that we're now in a stagflationary environment where both quantitative easing and quantitative tightening lead to the same exact outcome: recession.