Recent Technical Damage: Is Stock Market Set For Another Plunge

Marc Zabicki (00:00):

<Silence> Good day, ladies and gentlemen, this is Mark Zabicki, Chief Investment Officer at LPL Research. Joining me today for today's Market Signals is Adam Turnquist, Chief Technical Strategist. This is the Market Signals podcast, and we are recording September 25, 2023. Adam, how are you today?

Adam Turnquist  (00:21):

Hey, not too bad for a Monday despite a 0-3 Viking start. It's been a rough one so far this football season, but luckily there's plenty of football left, so, yeah,

Marc Zabicki (00:31):

I forgot you're a Vikings fan, so I, I guess you, you've struggled for decades now, so I can appreciate that. So, and speaking of struggling we've got a market that continues to struggle. You and I talked about, you know, as before we got on today the backdrop for risky asset prices really has been tumultuous really since August. And I know we're going to touch on, you know, some September seasonality, and we'll let you get into that. Also, clearly, your expertise is the technical side of things, so you know, assessing the damage of the recent pullback, and I think as you said in other forums, you know, there has been some technical damage to this market. So I'll let you get into that. We'll talk a little bit about is India the new China?

Marc Zabicki (01:26):

That's a very interesting question, and then we will leave it with where we are on the calendar for the week ahead in terms of some economic data, some important things that we'll call our attention to. But thinking about where the market's been in the recent, you know, recent day or three months or so, recent five days last week continues to be relatively tumultuous in terms of overall equity market returns. You know, not a whole lot of plus signs here over the last, you know, five days or so. And that's a function of really a market that typically has trouble in September, and I think we've noted that in several forums here at LPL Research. It's made a little bit more difficult by the question of whether we're going to get a government shut down or not, you know, et cetera, et cetera. And interest rates, which have, have caused some problems for the equity markets as well as you know, interest rates are causing some trouble across the bond market, across the, you know, the equity market and also really across the commodity market as well. So, anything that is really a risk on asset has had trouble over the last week. Any takeaways here, Adam, that you would point to in terms of the week's activity over the last five days or so?

Adam Turnquist  (02:59):

You know, Marc, when I look at all of these returns for the month of September, I kind of think back to that Green Day song "Wake Me Up When September Ends", and I think that's the vibe in the market right now. It's been a pretty tough month, S&P down three straight weeks. It's that risk off tone, as you mentioned, driven by this big jump in interest rates. So we'll take a look at that 10-year chart, some of the headwinds that that's creating, but for now, I think it's, you know, it's blame this week's September seasonals are blamed for a lot of this selling pressure, but of course, as we know, there's a lot of factors behind it. That big movement rates, policy uncertainty from the Fed. We have oil rallying right around $90 a barrel now on WTI and the dollar up for 10 straight weeks, which is a negatively correlated asset to U.S. equity. So that's, there's, the macro conditions are getting a little bit sloppy as we move ahead, fortunately to a bunch of better seasonal period coming into October, November, December, typically a pretty strong quarter end for the S&P 500.

Marc Zabicki (04:01):

Yeah, and we will see if the typical doldrums of September translate into more problems in October, given the government shutdown. As you pointed out historically, that's not the case, but we'll see if a government shutdown brings more uncertainty into this market. So technical update. Adam, let's start with the S&P 500, which everybody talks about. So, gotten a little messy here, so what's your assessment?

Adam Turnquist  (04:32):

Yeah, so market's been struggling really since we hit that July 31 high this summer, and we've consolidated for most of the period, just pulling back here, you can see we're now breaking down from what we call a symmetrical triangle formation. You can see we get to the fulcrum point, broke to the downside. Some people out there are calling this a head and shoulders top formation. I don't know if we can quite get there, but certainly not a good technical sign right now, at least on a short term basis. So let me frame it up there. This, if you look, you know, the October low and that uptrend that's formed there still intact, we're still above a rising 200-day moving average. And when you think about market breadth and how many stocks are holding up above their 200-day, that's been damaged as well, but we're still seeing more cyclical or offensive sectors hold up better than defensive sectors.

Adam Turnquist  (05:22):

So, the big question I'm getting is, okay, where does this pullback potentially land in terms of support? We think a logical spot for a bouncer or a recovery right around this 4,200 to 4,300 range, can see the 200-day moving average is pretty close to that level. That's an area where the markets had significant resistance and support. We talked about this 4,200 level a lot last year and into the spring, and then that 4,300 level goes back to the August, 2022 highs. So those are really the levels that we're watching technically on the market. And when you think just how much cash is on the sidelines in terms of money market assets, how many investors really missed this first half rally? There's a lot of skepticism over this bull market. I think there'll be a lot of that buy the dip crowd coming back into the market around those levels.

Marc Zabicki (06:09):

Okay. Good points. And as you mentioned, you touched a little bit on the market breadth and the cyclicals, you know, still getting some attention here. Any final thoughts on that point?

Adam Turnquist  (06:23):

Yeah, so the market right now, just under 50% of stocks are above their 200-day moving average. That's one of the breadth metrics that we like to look at. If you think just simplistically, if the most basic definition of an uptrend for some or in general is if price is above a 200-day moving average. So that's, you know, you could say just under half the S&P is now in an uptrend, but it's important to look at the composition of breadth here, and that's what we're doing with this chart. How many stocks in each sector are above their 200-day moving average? And you can see energy has had a big run over 90% of energy stocks above their 200-day. Technology, right around 63% of the tech sector still holding up above their 200-day moving average. So, despite some of the headlines about the magnificent seven stumbling a bit, and that momentum fading, the overall tech sector's doing relatively well, I think over half the sector is actually outperforming the S&P 500. I think that storyline gets lost in that magnificent seven narrative. But the other sectors that are offensive are still outperforming the defensive sectors. We have not had this big flight to safety, meaning assets moving into the more defensive sectors. You can see utilities, real estate, healthcare, consumer staples, the more defensive sectors, they have the worst breadth across the 11 S&P 500 sectors. So I think that does speak to the health of the bull market as of right now.

Marc Zabicki (07:46):

Yeah. And just for our work our asset allocation committee upgraded energy more recently here, so that's worked out for us given the strength in oil prices and just as you see here, stock prices as well. So transitioning from the broader, you know, 11 S&P 500 sectors to technology, what's the take here, Adam?

Adam Turnquist  (08:12):

Yeah, so last week, I think the chart of the week was really the 10-year Treasury yield. I'm going to call the technology sector the chart of the week. So I think investors should be watching this carefully because we're right at this inflection point near support on the technology sector. You can see that green line that we're coming in that represents a potential neckline of what we call a head and shoulders top formation. Not going to get too into the weeds on the technicals, but what you need to see is a break below the neckline for that formation to be validated. Otherwise, it could just be a consolidation level. So keep an eye on those August lows on the tech sector, we start breaking down, there's a pretty big pocket of air until you find support around the 200-day and the August 2022 high. So that's about a 9% drop until the next area of support. And if you extrapolate that into the S&P weightings, that could be a pretty big headwind for other sectors to absorb if tech starts rolling over. But again, we're still above a rising 200-day moving average, and I keep reminding investors and our advisors that pullbacks are normal within the context of bull market. So should not be surprised we're seeing a little bit of weakness, especially given the rally that the tech sector had in the first half.

Marc Zabicki (09:22):

Yeah, I mean, given the importance of this sector in the S&P 500, very important to watch because so much of what you know is driven in terms of market sentiment, it really starts with, you know, how folks think about technology. Now Federal Reserve policy, and this is real interesting in terms of the subject matter. With the 10-year Treasury yielded at 4.5%, you know, today. Higher for longer seems to be the mantra that certainly the Federal Reserve delivered last week, and the market seems to be buying it. Is that right or wrong, Adam?

Adam Turnquist  (10:02):

Yeah, that's certainly what the Fed is telling us, and I think we're acclimating to that world and the equity market. The big theme of the Fed meeting was, you know, proceed with caution, and I think that's how investors are looking at the market right now, just given the reaction. But there's a lot going on in this chart, Marc so let me just walk you through it. This is just a look at the dot plot compared from the June dot plot based on the Fed's Summary of Economic Projections to the most recent that we got in September. And you can see, if you look at the orange lines that shift higher that we've seen, that's really the fed penciling in a higher fed funds rate going out to 2024 and 2025. They actually revised the year end projections by 50 basis points at this meeting.

Adam Turnquist  (10:47):

And you can see just that narrow, that shift in the curve, it's that higher for longer shift. And that dotted blue line is actually the fed funds futures market. So that's really what the market is expecting based on the probabilities in that futures market. And what's interesting as well as, and on top of just this shift to hire for longer, is that we're still having a discrepancy between what the Fed's telling us and then where the market's actually projecting fed funds futures. So once again, the market's saying the, the Fed's likely not going to be as hawkish as they are saying, and that's historically correct. They're typically more hawkish in those projections than actual the reality. But we're still that discrepancy zone, I think that does suggest we might have some more volatility in the market as those two eventually converge into what we know as reality between the two. So it should be an interesting fall as we look at this, the fed funds market still a 50% chance for a December or a 25 basis point rate hike by December.

Marc Zabicki (11:50):

And the curious thing to watch, and it's come up in our asset allocation committee meetings, is if we do get a transition from inflation being the primary worry to economic growth being the primary worry, then what happens then to, you know, Federal Reserve policy expectations as a result of that remains to be seen. Right now, the Fed is certainly jawboning a stiff upper lip, if you will, in terms of the way it considers, you know, rates 10-year Treasury yield certainly is reacting to that here, Adam, so what's the take on this chart?

Adam Turnquist  (12:29):

Yeah, so this one is, it's pretty interesting. This was one of the, I think I flagged it as a chart that keeps me up at night as we were getting close to breaking out above those October highs at 434. And you can see the latest move we've actually broken out to new highs on the 10-year, or at least multi-year highs here for the 10-year trading rate around 450. And you can see the market's reaction as we've had this pretty big shift in terms of the rate of change in yields. That bottom panel looks at the actual correlation between the S&P 500 and 10-year Treasury yields. Part of the advance equity markets were able to absorb that rising 10-year, but as things accelerated, it was just simply too much, too fast as we did get that breakout point. And I think it really does change the narrative.

Adam Turnquist  (13:13):

If you think about last October when yields peaked, we subsequently pulled back pretty substantially and the message there and the theme was, okay, how low can rates go? And now that narrative's changing of how high rates will go, and we see in terms of overhead resistance, next major spot is going to be about 470. That goes back to some early or mid-cycle 2000 highs. So there's definitely some room to go higher in 10-year yields. I think that could be problematic, at least on a near term basis for U.S. equity markets.

Marc Zabicki (13:45):

Yeah. And then, you know, you touched on a little bit of this in terms of historical drawdowns. Every year seems to come with one. And so what some of what we're seeing already in August, September, you know, call it, you know, five and change 5% and change down for the S&P 500, you're not getting a whole lot of help out of the Bloomberg Aggregate Bond Index either because that's down 2% or so as well. So tumultuous times like this, even though we've had a smooth ride up until up until really August, people shouldn't really be surprised. Adam, your assessment.

Adam Turnquist  (14:31):

Yeah, it's pretty much an orderly pullback and we put some context around it with this study. So we looked at performance into September across every single year for the S&P going back to 1950, and we ranked those windows of performance based on decile. So, your top deciles are your best performing periods, obviously your, your lower decile are the lower momentum or worst performing times between December 31 to August 31. And then we actually looked at how the market performs from September to year end. You can see there the average return is about three point a half percent, but we also looked at the average drawdown between September and year end because we really wanted to see are above average years do they experience larger than average drawdowns, just some of that mean reversion. What we found is that typically you can expect a drawdown maybe between the five to 10% mark, even when you have a strong momentum year. And you can see that in those kind of the top decile ranks, even the best decile ranked up 20% into September. The average draw down there is about 9.7%. So again, nothing out of the ordinary here. And if you look at volume in the market, it's been below average. You look at the VIX struggling to even get past the 200-day moving average, we haven't had that major flight to safety. So, for now, this looks like a pretty routine pullback of some overbought conditions that we had this summer.

Marc Zabicki (15:53):

Yep. And then shifting gears here just a little bit, you know, looking from U.S. markets to international markets and, boy, you know, China's not been a good place to put money to work for multiple years now. And it's certainly a big weight on the MSCI Emerging Market Index. I think it's roughly 30, 35% of the index or so. But China may offer for those BRIC investors, the right part of that acronym to choose in the eyes. So, taking a look at India, Adam, just from a technical perspective, there's a little bit to be happy about if you're long India, what, you know, what's the story here?

Adam Turnquist  (16:45):

Yeah, so you can see here on the top panel, this is the MSCI India index and investors have been waiting for about two years to get to new highs. We actually just broke out to new highs on that index. So breaking out of, from a long-term consolidation range, typically these suggest that's a sustainable trend change. You had kind of this parabolic move, a lot of those gains were likely consolidated or there's kind of a shift in the market as we work through that overbought condition. And now you can see the trend continuing breaking out to the top side here, and then when you compare it on a relative basis to China, that's that bottom ratio chart, you can see through 2013 through about 2021, that ratio chart really went nowhere. That's suggesting there was kind of fits and starts between leadership between India and China going back and forth.

Adam Turnquist  (17:34):

But in 2021 you had a massive breakout on that ratio chart that's powered by India outperforming China. And that really accelerated at the beginning or start of this year. You can see that ratio chart finding support and continuing higher. And if you think about India, why is it outperforming China? It's really just a growth story. You can see it in their population base. There's now just about 1.5 billion people in India. It actually knocked China off the top most populous country for the first time since 1950. So they have a huge growing population. And what really stands out with India is just in terms of their age of their population. So the median age there is about 28. That's almost a decade younger than China. So what that means, you have a robust workforce. That's something China's been missing. You can see that in some of their youth unemployment data that they're no longer publishing by the way as they recalibrate it.

Adam Turnquist  (18:33):

But you're also seeing rising real wages as India starts to move their impoverished area of their economy to more middle class. So there's a lot less people impoverished in India and then they have a huge jump in infrastructure spending. They're spending around $2 trillion between 2019 and 2025. So they're rebuilding highways, building out a whole digital transformation. There's actually, I think 900 million subscribers to the internet in India. And a lot of those are doing more mobile transaction. It's becoming a lot easier to do financial transactions as they kind of adapt to this new digital world. So it's a pretty compelling growth story. On the equity side, of course, earnings are growing. GDP is growing. We'll take a look at that and you can see if you go to the next chart, just all of that growth story. Of course, if you follow the money, which investors do, and you can see the comparison here, we make between net foreign equity investments in China, that's the orange line.

Adam Turnquist  (19:34):

That dark blue line is India. And this is just really foreign ownership of domestic equities in either India and China. And I think what's really compelling here is just the outflows, the deceleration in equity movements into China over the last couple years. Of course, there's trade tariffs, there's escalating geopolitical tension, there's the Taiwan, we'll call it a dark cloud over China. And I think some of those outflows have been moving into India, and you can see they've been accelerating really since March of 2022, as more and more equity is going after that growth story in India.

Marc Zabicki (20:11):

Yeah. And in addition to just like the growth story that you outlined, you know, Adam, if you look back over the last 20 years of the four BRIC countries, maybe India's the one that you can point to that's, you know, more sustainably westernized as opposed to the other three. And whether, I mean, obviously the relationship with India and western economies is not necessarily perfect, but perhaps more perfect than it is for Brazil, Russia or China. So good, you know, good points there. The GDP growth in India now out pacing China, which is probably a surprise for a lot of people. But it is in fact the case. Any comments here, Adam?

Adam Turnquist  (20:58):

Yeah, I mean it's pretty interesting to see that change in growth. And you can see as you extrapolate the forecast out to even 2026, you're talking about growth in India, you know, seven to 8% forecasted and China growth around 5%, which, you know, on the surface that sounds pretty high, 5% GDP growth. We would certainly take that in the U.S. We're not an emerging economy of course, but the India story I think has a lot more credibility in terms of the growth. I think it's a better theme. And I think China's just has got a lot more work to do on the economic side. They're continuously introducing new stimulus measures and trying to revitalize a pretty dire economic situation, whether it's their property sector, some of their shadow banking. And it's kind of a different narrative too on the political realm. You know, the U.S. and a lot of the G20 is working with India, building this new corridor in the Middle East or that goes through Asia. At least they're planning to verse, you know, the U.S. and China, which are diverging in terms of policy overall, I think.

Marc Zabicki (22:05):

Yeah, yeah. And near shoring also something of interest when it comes to China as well.

Adam Turnquist  (22:15):

Yeah. And that's another one that's India's benefiting at. I think China's loss here. And you can see that transition in terms of exports as a percentage of GDP. India is now actually exporting as that percentage of GDP more than China. Big driver of that has been companies moving away from China after what we witnessed in the pandemic world. A lot of those supply chains became snarled. And there's also the trade tariffs and all of the other political ramifications that you get when you invest in China. Now they're moving those to India. It's got obviously that workforce that we talked about. And you can see that in the total overall production in terms of their exports. They're actually, right now they're about the 10th largest exporter in the world and forecasts by 2029, they're expected to be the fourth largest exporter. That's pretty significant growth in such a short period of time. So again, it just adds to that growth story, not just domestic consumption. It's also becoming more export oriented.

Marc Zabicki (23:18):

Yep. So just maybe putting a bow on that, you know, Adam, as we think about emerging market exposure, I mean we've kind of long said that you just can't get it in kind of blanket ETF exposure at least. You can get it, but it is something perhaps not the best way to treat emerging market exposure. You've got to be a little bit more specific with where you're putting your money to work. So, if you just go out and buy a broad-based ETF given the China weight, you're probably doing yourself a disservice. So we've been suggesting, you know, active management is the place to be in emerging markets and what's going on in terms of the variance between India and China, you know, certainly leads us to that conclusion as well.

Marc Zabicki (24:06):

Looking ahead this week, there's a couple things we're going to point to from the U.S. economic calendar. Consumer confidence coming out from the conference board that'll be tomorrow. So that people will keep a good close eye on that. Certainly, some of the S&P core logic data, some of the new home sales data also going to be important. But the consumer confidence number will probably be number one on people's minds tomorrow. Midweek durable goods numbers. And then toward the end of the week personal income and spending actually is going to be interesting as far as we're concerned. Because we're wondering if the consumer after vacations are over and after a lot of money has been spent both on, you know, products and now services, whether the piggy bank is getting a little bare there, so we'll see if that's a read through personal income and spending and also some of the University of Michigan sentiment numbers, given what's going on with, you know, a potential government shutdown, et cetera. We'll see how people feel about the expectations and current conditions on Friday as well. Any last comments, you know, Adam, before we close it out?

Adam Turnquist  (25:33):

No, I think you nailed it. I mean, that PCE number, we'll be watching closely and see if that throws any cold water on this interest rate rally. You know, it's either going to be gasoline or water. So that one's going to be definitely on my radar as we look at the market on Friday.

Marc Zabicki (25:48):

Okay. Ladies and gentlemen, thanks for joining us for this Market Signals podcast. Again, joined by Adam Turnquist, our chief technical strategist. My name is Marc Zabicki, and have a good week.