• S&P 500 recovers to the close as option expiry boosts stocks.
  • S&P 500 is now though officially in a bear market. 
  • Nasdaq closes in the red while Dow Jones Index is flat.

Another wild and volatile week which seems to be the tone so far for 2022. Wild swings throughout the week were mirrored on Friday with wild intraday swings. The S&P 500 did manage to slide into a bear market territory on Friday. While there is no real official designation for a bear market the generally accepted consensus is that it's 20% from peak. The Nasdaq long ago meet this criterion but the S&P 500 has been flirting all week with the level. The job nearly looked to be done on Wednesday after Target (TGT) sounded alarm bells with its margin pressures and lowered guidance. Friday got the job done but with options expiry, in the afternoon the anticipated flows were always likely to see a late-session rally. 

Next week sees more retailers lined up to report earnings and after Target and Walmart the bar has been set pretty low. This could set up a counter-rally with any sort of relief on earnings and or outlook likely to see a big move to the upside. Next week Costco (COST) Dollar Tree (DLTR) and Dollar General (DG) are the big earnings up. 

Sentiment and positioning continue to suffer in the wake of recent volatility. The CNN Fear and Greed is at extreme lows. The American Association of Individual Investors (AAII) is at a recent low and the Investors Intelligence survey is also at lows not seen since the last rally post the Ukraine invasion. Back then we got a confusing rally but investors are slightly more attuned to the potential countertrend rally so that is perhaps the main reason we are not getting it! But next week sees corporate buybacks step up as earnings season ends. Also of note is hedge fund and mutual funds positioning being notably underweight equities. This will likely mean if we do get any sustained rally, the hedgies and fund managers will eventually rush into reposition and push it higher. Also worth noting is the latest Commitment of Traders report from the CME showing commercials are net long equities while speculators are short. Commercials are generally a better indicator although the correlation is not strong. 

But now that we are in a bear market with the 20% intraday decline let's take a look at the stats. We are nearly 5 months in but the average bear market lasts just under 10 months and sees an average 38% fall. So looks like we are halfway there then in terms of time and percentage drop. Valuations would certainly point in this direction. The S&P 500 is still trading at nearly 20 times price to earnings, P/E ratio. This is historically high and indicative of a bull market. The right metric for a recession and or inflationary environment is nearer to 10! Over the past 140 years, the average P/E is 15 for US stocks. So definitely more room to the downside then. 

SPY stock forecast

So we are going with a short term rally up to perhaps $435. But we still face challenges in the long-term macro picture. Inflation looks like it is spreading and sticking. This is not yet anticipated by either the bond market or the equity market. A recession is now priced in by the bond market with long-end yields falling. But the front end is not pricing in an aggressive enough move in our view. We have recently had incredibly hawkish statements by the Bank of England saying inflation will hit double figures. Wholesale Prices (PPI) in Germany just increased by over 30% yearly. There is a lag between PPI flowing into CPI. Germany is not the USA but its economies do share distinct similarities. The inflation storm looks to be only starting. With US employment markets incredibly tight, wage demands will rise and will have to be met as employers are struggling to fill vacancies and keep existing staff. This is how inflation becomes entrenched. Eventually, demand destruction will set in.

Now not only did Friday's intraday sell-off result in a 20% bear market decline. But it also hit the 38.2% retracement of the move from pandemic lows to the peak in January. The first resistance is at $415 and then $435.

SPY chart daily

Nasdaq (QQQ) forecast

The Nasdaq chart looks even worse. Notice the big volume gap we are now in. This does not resolve until $200. Yikes. A quick short sharp rally may not be far away as both RSI and MFI look very close to oversold levels. But with inflation sticking around and the Fed having to fight then the Nasdaq outlook is decidedly grim.

Nasdaq (QQQ) chart, daily

Economic releases

The author is long IUSA and short Tesla and Twitter


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