ETFOptimize Insights

Last Friday, the S&P 500 ETF (SPY) and NASDAQ 100 ETF (QQQ) both closed the week below their 50-day moving averages. At the time, we pointed out that the 50-day moving average was providing support for many indices and equities, with prices stalled just above the 50-day EMA for the last two weeks. We noted the possibility that pent-up bearishness selling pressure could cause prices to surge lower if and when the 50-day support level was pierced. That has occurred now, so we shouldn’t be surprised if we see further price declines this week.

Have Investors Had a Change of Heart?

Perhaps a harbinger of things to come, stock prices did the opposite of their past action following the Wednesday, September 14 press conference by Fed Chairman Jerome Powell (transcript). Powell, who may have called the conference in hopes of shoring up investor confidence as stock prices recently weakened, said that “interest rates will stay low for many years, possibly until 2023 and beyond.”

Powell also said that the Fed’s forward guidance includes continuing to purchase roughly $80 billion a month in Treasuries and $40 billion per month of Mortgage-Backed Securities (MBS). By far, this rate is the highest level of quantitative easing (QE) ever extended to support market prices, but it may not have been enough to prompt renewed stock buying.

“We do think that these purchases have been effective in restoring early market conditions and have supported the flow of credit to households and businesses, including by fostering more accommodated financial conditions, which of course we think is a good thing.”

– Jerome Powell, US Federal Reserve Chairman, Sept. 16, 2020

Instead of surging higher based on continuing support, we immediately saw lower prices after the press conference finished on Wednesday afternoon. Then prices became even weaker on Thursday and Friday last week.

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This outcome may be a marker of an inflection point in the minds of investors. In past recessions and earlier this year, Fed communications that supported the market inevitably resulted in higher prices. However, when investors have had a sentiment change, it doesn’t seem to matter what Fed representatives say. When investors become bearish, there is little that will change the internal negative narrative. As we have pointed out in prior communications, external support can only go so far. If valuations no longer make sense, investors will reduce their purchases. That appears to be what’s happening now.

Chart 1 below shows the S&P 500 Large-Cap ETF (SPY) breaking its 50-day EMA (dotted-green line) on Friday in the top window. The lower window signifies that only a little more than HALF (55%) of S&P 500 shares are above their 50-day Moving Averages:

SPY - 50-day Support BreakChart 1 (click to enlarge)

Chart 2 below: Mega-cap technology stocks led the market higher off the March lows, but investors now appear to be turning away from those severely overvalued shares. Leading stocks in the NASDAQ 100 ETF (QQQ) include Apple (AAPL), Facebook (FB), Alphabet (GOOG), Microsoft (MSFT), and Amazon (AMZN), among others-with an average PE Ratio of 35. Each of these individual equities dropped below their 50-day moving average last week-pulling the Nasdaq and S&P 500 indices down with them.

As we can see from the lower window in Chart 2 below, there are currently only 33% of NASDAQ stocks remaining above their 50-day Moving Average.

NASDAQ 100 Support breakChart 2 (click to enlarge)

The 200-day Moving Average for the SPDR S&P 500 ETF (SPY, Chart 1) is currently about -7.1% lower than Friday’s close, so dropping to its 200-day level would effectively double the decline to-date, totaling about -14%. For the NASDAQ 100 ETF (QQQ), the 200-day Moving Average is -13.2% lower than today’s level, which would be a total decline of about -24% since the ATH at the September 2 close.

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At the September 2 closing high, the NASDAQ index reached a whopping 33.8% above its 200-day EMA. The S&P 500 also touched an extreme level at 16.9% above its 200-day EMA. These indices had touched levels that they could not sustain, and the recent pullback is healthy for a continuation of the rally. Had shares continued rising to even more extreme levels above their mean, the inevitable crash could have been devastating.

Fundamental Indicators Remain Bearish

Should the S&P 500 and NASDAQ indices pierce their 200-day MA’s-then look out below. There are a plethora of macroeconomic and stock fundamental indicators that would support a continuing market decline.

One of these negative fundamental indicators is the S&P 500 earnings series. We use a progressive blend of past, present, and future earnings, derived from trailing twelve months (TTM) actual, Current Year (CY) forecasts, and Next Year (NY) forecasts, respectively, to derive our Progressive Blend Earnings Composite (PBEC). We named this composite “$FRS01_PBEC” in our Risk Score series, with its name representing that it is part of our Fundamental Risk Score (FRS) indicators.

Chart 3 below shows that this indicator is still showing a reading of 0 (zero), suggesting that S&P 500 earnings still have a high-risk status. Blended earnings remain more than -15% below their February level, while the S&P 500 ETF (SPY) surged to an All-Time High that surged past the level in February.

Progressive Blend Earnings CompositeChart 3 (click to enlarge)

Macroeconomic and fundamental indicators remain overall bearish, while some technical indicators are providing us with a different view.

Technical Indicators Are Overall Bullish

Chart 4 below shows one of our most effective Technical Risk Score indicators-$TRS05-offering five risk assessment levels. This indicator is currently at a reading of 5.0 on a scale of 1-5, meaning that the indicator is at its most bullish possible level.

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Constructed from a composite of the Rate of Change (ROC) of 14 different SMA and EMA moving averages, this indicator provides us with a measure of the strength and severity of a market decline. With most indices breaking their 50-day Moving Average last week, so far, this has not caused this particular Risk Score to drop from its most bullish reading at 5.0.

Technical Risk Score 5 ($TRS05)Chart 4 (click to enlarge)

Conclusion

Market risk indicators are very mixed, with a wide range of readings. With the most well-known indices breaking their 50-day Moving Average at the end of last week, this week, we will see if the downturn continues and, based on its strength, assess the severity of potential market losses.

If we see a very aggressive decline from below the 50-day average, with investors unloading richly priced equities ‘en masse, that momentum could carry stocks significantly lower. On the other hand, if prices meander about below the 50-day average this week without gaining momentum, that will imply that most investors have not had a substantial change of heart and, overall, remain bullish on the future of equity prices.

To learn more about ETFs’ advantages over individual stocks and mutual funds, please see this article in our Introduction Section, titled “Why ETFs are Today’s Investment of Choice.” To learn more about quantitative investing’s advantages, please see our article titled “The Benefits of Systematic ETF Investing.”

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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