Although signs of distribution in equities have been emerging for several weeks, in the last week, downturns have become more decisive with breakdowns by the NASDAQ Composite indicating weakness in technology/communications stocks, and by the Russell 2000 indicating a broad-based aversion to small caps intensifying. The deepening market downturn can be attributed to two main factors. First, increasing fears that we could be heading into a period of stagflation (high inflation, rising interest rates and a weak economy). Continued signs of rising inflation coupled with rising energy prices, the US 10-year treasury note yield driving back up above 1.85%, and both retail sales and industrial production reports souring sentiment sending investors to the sidelines. Back in October, weakening equity markets were saved by a strong earnings season. This time around, however, initial earnings reports have been mixed with several big US banks reporting disappointing results and raising questions about the impact of the Omicron Wave, supply chain disruptions and other economic issues may have on business conditions and corporate earnings. The forces of inflation/monetary policy and earnings/guidance remain front and center in the coming days. Wednesday the 26th is a rare occasion where both the Federal Reserve Board and the Bank of Canada are meeting and announcing monetary policy decisions on the same day, which could provide insight into the impact of growing stagflation on monetary policy. Earnings season continues to expand over the coming week as well. The next ten days bring results from a wide variety of groups in the US, including Big Tech, Big Oil, credit card companies, industrials, restaurants, miners and others. Earnings season starts in Canada as well, beginning with Rogers and the two big railroads. In this issue of Equity Leaders Weekly, we dig deeper into the technology sector downturn, and at capital rotation into resource-sensitive emerging resource markets.
The NASDAQ Composite Index (NASD.I), with its higher concentration in growth/momentum stocks in the technology and communications sectors, tends to be seen as indicator of investors’ appetite for risk. Trading action in the NASDAQ over the last three months indicates that a significant reversal in investor sentiment has occurred from enthusiasm to caution to fear. For the last three months, the NASDAQ has been unable to shake off increasing investor concerns about rising interest rates, high growth equity valuations, and a weakening economy, leaving it unable to get back to its November peak, unlike its peers the Dow and the S&P 500. This month, it increasingly feels like the dam has bust and the flood has started. NASD.I has staged a decisive downturn under 15,000, completing a bearish Double Bottom pattern to signal the start of a new downturn and carrying lower. In fact, two bearish Double Bottoms in succession combined to create a rare pattern called a Bearish Catapult (circled) that has hurled the index into a Bearish Low Pole decline. This breakdown has been confirmed by similar downturns in technology sector indices including the NASDAQ Biotechnology Index (NBI.I), the NASDAQ Internet Index (QNET.I), and the Philadelphia Semiconductor Index (SOX.I). Back in 2020, many stocks in the NASDAQ had benefitted from the shift to a stay-at-home economy, it’s also possible that investors may be starting to anticipate a return to work and a return to normal could have a negative impact on the prospects of some companies in the technology and communications sectors where the NASDAQ is particularly sensitive. Currently, NASD.I is testing support near 14,255. Should that fail, next potential downside support may appear near 13,975 based on a previous column high, or 13,165 based on a horizontal count. Initial resistance may appear near 14,985 based on a 3-box reversal and a retest of a previous breakdown point. With a bearish SMAX score of 5, NASD.I is exhibiting weakness relative to the asset classes.
In our new quarterly chartbook and in recent issues of the Equity Leaders Weekly, we have highlighted a number of charts showing capital rotation back into resource markets including crude oil/energy stocks, copper, and lumber. We have also indicated that the current shift toward a more cautious stance by investors in general has had a negative impact on emerging markets.Recent trading action in the iShares Latin America 40 ETF (ILF) suggests that for the emerging markets which are more sensitive to resource sectors (in this case about 30% Energy and Materials), rising energy and metal prices are becoming strong enough to offset broader equity market headwinds. ILF spent the second half of 2021 trending steadily downward, but since the beginning of this year, distribution has changed to accumulation. Earlier this month, a bullish Double Top breakout signaled the start of a new upswing which has since been confirmed by a bullish Spread Double Top breakout. ILF has also snapped a downtrend line and closed above $25.00 yesterday. Previous column highs/lows and horizontal counts suggest potential upside resistance near $26.25, then the 29.80-$30.40 area around the $30.00 round number. One issue that investors can encounter when trading in emerging markets is higher political risk, a factor that rarely impacts trading in developed markets. A recent case in point is the Russian stock market. Considering that the S&P Russia BMI Capped Index is weighted 44% to Energy and 21% to Materials, one would have expected that index to be soaring with crude oil breaking out again yesterday to its highest levels since 2014. Instead, the iShares MSCI Russia ETF (ERUS) has been plunging lately, with energy market gains overshadowed by rising political tensions and the current elevated threat of war between Russia and Ukraine. Yesterday, ERUS did manage to stage a 3-box upward reversal on the back of rising oil and metal prices but it’s too soon to say if this is a blip or the start of a turnaround. It would take a move back up above $40.00 to complete a bullish low pole warning and call off the currently active Spread Double Bottom signal. Next downside support appears near $35.75.
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