Category: Newsletter

While the market struggled to advance early in the week, on Thursday and Friday, markets climbed to set new closing highs for the year, as shown. However, the combination of overbought conditions and excess bullish sentiment limited gains from weaker-than-expected economic reports that should keep the Federal Reserve at bay next week. It is worth remembering, however, that we are still lower nearly two years later. Most investors have spent the last 15 months making up losses, and markets may struggle next year.

It's that time of year when Wall Street analysts start pinning targets for next year's performance of the S&P 500. Unsurprisingly, they are unanimously bullish, but there is a simple reason for that, which we will discuss today.

The rally continued this past week, and we are approaching the 100% retracement of the July highs. Such changes the dynamics of a pullback to the previous resistance levels of 78.6%, 61.8%, and 50% retracements. With the 50-DMA coinciding with the last 50% retracement level, we expect the maximum drawdown of any correction to hold that level going into year-end.

Market rallies are common heading into year-end, and this rally is no different. However, we are now reaching more extreme levels of typical reflexive rallies, and a consolidation or correction to support should be expected.

Mr. Powell heard our concerns, and on Thursday, he responded to the recent loosening of financial conditions. As discussed below, the recent drop in bond rates and surge in the stock market works against the Fed's goal of tightening monetary conditions. The Fed's goal remains "tighter" conditions to reduce consumer spending and increase unemployment to reduce economic demand. The demand reduction is how inflation, which is solely a function of supply and demand, gets reduced.

On Wednesday, Jerome Powell's speech sparked a broad rally in stocks and bonds as market expectations for further rate hikes collapsed. There was nothing new about the Fed's recent policy announcement as they maintained that higher Treasury yields are doing their work in slowing economic activity and, ultimately, inflation. However, they did, again, as expected, leave open the possibility of further rate hikes as needed.

Possibilities and probabilities are currently difficult to evaluate. The drubbing the market took this week was undoubtedly disappointing. However, the market is approaching deep oversold conditions with some minor support heading into next week. Since March, whenever the market reached such oversold levels, a reflexive rally has ensued.

As we will discuss, the conflict with Israel took center stage this past week. However, the markets also had to deal with PPI, CPI, and the official kick-off of earnings season. From a market trading update perspective, let's start with a review from last week.

The market fell sharply in what felt more like a liquidation event early in the week. The market failed to hold that initial support level and quickly tested the 200-DMA as expected. The good news is the market bounced sharply off support levels on Friday, reducing the MACD "sell signal." If the market can follow through on this rally early next week, we could see a "buy signal" triggered.