Capitulation Nation

Now that all thoughts of a soft landing have been dashed and a bear market has been universally declared, we can sell everything, relax and go to the beach - right? Not so fast Lazybones, given the sentiment backdrop, there's a trade afoot. But when?

Signs of capitulation are multiplying. The 'I told you so' crowd is out in full force today with its comments.

"Meme stocks are a distant meme-ory."

"Now that her Fed-sponsored concert has ended, TINA has left the building."

"The new FOMO is 'Fear Of Maintaining Ownership'."

And my favourite headline this week was Jason Kirby's Globe and Mail article entitled "It's Hip to be Bear" - an instant classic!

With this backdrop, I believe we can get a durable bounce out of this market but a few things have to fall into place fist. Certainly, with the sudden realization that the Fed is now having a 'Volker' moment on inflation, we can safely say that risk-taking is under a serious attack. But it is far from an existential one. A long overdue repricing of both administered assets and their risk-adjusted compatriots shouldn't be conflated with a complete end-game for investing. Isn't it incumbent upon those who still participate in the capital formation process to carry on carrying on?

I'm now smelling opportunity in the air but it's still faint. The turn will revolve around a sudden realization that the monetary medicine being doled out by Chair Powell has broken the fever of inflation. So where can we look to find the signs? Like most fevers, the outward manifestations, sweating, and runny nose, are the most obvious.

For the market, it's the declines being exhibited by the broad averages. But as with influenza, it's the internal inflammatory viral load that usually breaks first - you need a thermometer to gauge that. It's the same for markets.

Breadth, Volume, and Leadership are the 'internals' that I look to for signs of a bottom. And what I'm seeing so far is a mixed reading on my market thermometer.

The Breadth of recent sell-off has been broad as even energy stocks have succumbed to the selling.

The NYSE Advance-Decline Index made fresh lows, with a reading well below anything seen in the last 15 years. Perversely, it's good to see such a plurality of selling. It smacks of capitulation. But I now need to see another post-bounce test of this reading in order to set up a non-confirmation, as is typical of past major lows.

NYSE: Advances - Declines

As for Volume, there is a glimmer of hope but it is still fairly dim. As shown below, the Chaikin Volume measure (an index similar to OBV) is demonstrating a similar non-confirmation as was seen at the recent top. This Indicator called the top nicely but has a more mixed record on calling bottoms.

For more on the Chaikin indicator go to:

https://currency.com/how-to-read-and-use-the-chaikin-money-flow-trading-indicator

SPY with Chaikin Indicator

As recent ETF fund flows indicate, there is still a fair amount of support from buyers in this market, which is encouraging. Alternatively, this bottom fishing behaviour may need to wrung out of the market before a durable low is made.

Headline from FACTSET:

ETFs Added Nearly $15B Last Week By Heather Bell June 13, 2022 "Despite dispiriting news about inflation, last week’s inflows were fairly strong."

And what about Leadership?

Small-Cap stocks are hanging on to their lows here. This would seem to support the notion that they are more immune to the valuation compression that has decimated their Large-Cap brethren. Look to them to lead a recovery rally should the Fed signal a backing off of their hawkishness, allowing for an economic rebound to form. Unfortunately, a prolonged tightening cycle that pushes the economy into a deeper slowdown could cause this ratio to break lower.

Small-Cap ETF vs Large-Cap ETF

Value against Growth has broken out of a huge basing pattern that began during the meme-stock mania and resolved higher once the Fed took the punch-bowl away from the expensive parts of the market. It represents a restoration of balance that had been sorely needed since the onset of the Fed's QE policies that distorted the valuation dynamics of the equity and bond markets. They helped create the growth bubble that gave us Tesla, Gamestop, and Bitcoin and they seem to be comfortable destroying it.

Value ETF vs Growth ETF

As for those who still think Bitcoin is a viable currency, think again. It was never a store of value, a unit of account, or a medium of exchange - the hallmarks of a true currency. It is now unlikely to meet any of those aspirations. The Fed allowed the asset inflation game - including crypto - only as long as it didn't spill over into the real economy. Now that the real-world inflation fight is on, we are seeing the complete unwinding of the false narrative of credibility that has surrounded these schemes since their creation. Sorry Libertarians, your day is still yet to come. We are one Coinbase margin call away from sub $10,000.

So I'm not much help here to those of you looking for a clarion call of 'all clear'.

The capitulation process may need to proceed a bit further yet. Just the fact that this piece is looking to identify the 'bottom' is a bad sign. Most bear markets end only after the temptation to bottom-fish has completely been eliminated from traders' minds. Mine included!

Risk Model: 0/5 -Risk Off

Rarely have I ever seen such a viscious reversal of the Model! Last week's 5/5 reading was obliterated in just five days. I felt a bit cavalier but advising against the Model's buy signal last week, but I had no idea it would so abruptly reverse. But that doesn't mean I'm gonna go against this new bearish set-up. As pointed out last time, there is a bit too much repair work in the major trends for Volatility, CU/Au, and AAII Sentiment to be a complacent bull here.

As I have repeatedly said, we will need more bad news for the Fed to reverse course. In the meantime - "don't fight the FED" is a time-honoured mantra to keep in mind. Stocks are a monetary phenomena, and this Fed seems to mean business. Bad business.