Mkt/ETF Commentary – Volatility and Bear Markets, Perspective on the Sharp Bounce in Stocks and Decline in Commodities (Premium)

The idea was to continue the Trend Composite series today, but the markets are moving fast so I thought I would address yesterday’s big bounce in stocks and the big declines in the commodity related ETFs. These moves did not reverse existing trends. Stocks are still in downtrends and commodities are still in uptrends. Volatility is through the roof and many commodities were going parabolic last week. Thus, sudden and sharp pullbacks can be expected. We can also expect sudden and short bounces in stocks. Let’s put these into perspective.

Better off Avoiding Stocks in Bear Market Environments

The Composite Breadth Model turned bearish on February 16th and remains bearish. This means the Market Regime is bearish and we are in a bear market environment. No two bear markets are the same when it comes to durations, declines, downside participation and trajectories. We can learn from the past, but predicting the outcome is usually a lesson in futility. The Market Regime is what it is and remains so until the evidence suggests otherwise.  

A few stocks, perhaps 20%, will buck the bear market. The challenge is picking stocks and stock-related ETFs that will not be affected by the bear market. This is easier said than done and this is the reason we should raise cash during bear markets. The odds are less in our favor.

Here is a short CNBC video where Jason Trennert of Strategas talks cash and his view that multiples will contract further.

Volatility Increases in Bear Markets

We should expect big bounces in bear markets because volatility increases in bear markets. The first indicator window shows the 22-day SMA for the absolute percentage price change (daily). Absolute means a 1% decline and a 1% advance are both valued at 1%. Both are 1% moves, just in different directions. The 22-day average covers four weeks or about a month. The red lines show when this indicator exceeds 1%, which means the SPHY is moving more than 1% per day on average. That’s a lot for a broad index ETF. This is above average volatility and confirms that risk levels are above average. Trade accordingly with smaller positions and higher cash levels. Oh, and do not confuse volatility with vitality.

The Trend Composite aggregates trend signals in five trend-following indicators: 5-day ROC of 125-day SMA, Bollinger Bands (125,1), Keltner Channels (125,2,125), CCI (125) based on Closing Prices and StochClose (125, 5). You can learn more about the Trend Composite here.

The Trend Composite is part of the TIP Indicator Edge Plugin for StockCharts ACP

Volatility Means Short and Sharp Surges

The prior two surges were sharp and short-lived. SPY became oversold on January 24th, stalled a few days and then surged 6% in four days. The ETF was again oversold on February 23rd, opened with a 2.5% gap down the next day and then surged over 6% from this gap. SPY was again oversold on Tuesday and surged 2.7% on Wednesday. The blue arrows show each oversold level. Note that SPY forged lower closing lows before each bounce. Combine this with lower highs and the immediate trend is down. The big oversold bounces are expected because volatility is above average. More importantly, I will not take these bounces seriously until there is a breakout of sorts and some sort of breadth thrust.

Advance-Decline Percent: Daily versus Smoothed

I watch the Advance-Decline Percent indicators for signs of a breadth thrust and an early signal that the trend could change. Advance-Decline Percent is the percentage of advancing stocks less the percentage of declining stocks within the major indexes. If 90% of stocks in SPX advance and 10% decline, then AD% equals +80%. Values above +80% show broad participation on the upside, while values below -80% show broad participation to the downside.

The chart below shows $SPX AD% exceeding 80% on February 25th and March 2nd (green shading). $MID AD% exceeded 80% three times in the last few weeks and mid-caps show the most upside participation of the four indexes. These are strong readings, but they are part of oversold short-lived bounces and interspersed with negative days. Follow through is needed to turn an oversold bounce into a breakout and a more meaningful breadth thrust.

The 10-day EMA of AD% is my go-to breadth thrust indicator because it covers two weeks and it takes more than just an oversold bounce to trigger. A move above +30% triggers a bullish breadth thrust and a move below -30% triggers a bearish thrust. The red arrows show bearish thrusts for the major indexes and the green arrows show bullish thrusts. The blue arrows on the price chart show when at least two of the four indexes triggered thrust signals. As you can see, all four triggered bearish breadth thrusts on January 22nd and three of the four triggered again on February 23rd. The strong individual days on the prior chart did not affect the 10-day EMA of AD% because we have yet to see strong and convincing follow through.

Small-caps are Holding Up, But…

SPY and QQQ forged lower lows and lower highs since late January and are leading the major index ETFs lower. The S&P SmallCap 600 SPDR (IJR), S&P MidCap 400 SPDR (MDY) and Russell 2000 ETF (IWM) are holding up better because they formed higher lows. I am not buying into short-term relative strength in small-caps and mid-caps though. First and foremost, the Market Regime is bearish. Second, the Trend Composite is negative for IJR, MDY and IWM. The odds are against an upside breakout in small-caps. More likely, I view the current consolidation as a bearish continuation pattern. The small triangle or pennant is a rest after breaking the March 2021 low. A pennant break would signal an end to the consolidation and a resumption of the bigger downtrend. Note that I am not interested in short positions because short-term counter-trend bounces can rip your face off.

You can learn more about exit strategies in this post,
which includes a video and charting options for everyone.

Staples are Holding Up, But..

The Food & Beverage ETF (PBJ) is holding up better than SPY this year, but the ETF is still down year-to-date and last week’s breakout did not hold. A failed breakout should not come as a surprise in a bear market. Archer-Daniels Midland (ADM) is the top holding (5.41%) and this agricultural commodity processor is up 21.6% year-to-date. The PerfChart shows year-to-date performance for SPY, PBJ and the top ten holdings. ADM, ACI and KR are leading with the biggest gains. Five of the top ten holdings are down year-to-date.

The price chart shows PBJ surging 6% in six days and then falling 3.5% the last three days. Even PBJ is not immune to volatility. The ETF is also unlikely to be immune to a bear market. It may go down less and show relative strength, but it is likely to come under pressure because it is still an equity related ETF. Ditto for the Consumer Staples SPDR (XLP). Procter & Gamble (PG) is the largest holding in XLP and it is down 8% year-to-date.

A Few Stock ETFs in Uptrends

There are relatively few stock-related ETFs in uptrends, which is to be expected in a bear market environment. Those that are in uptrends may offer some exposure to stocks, but keep in mind that risk is still above average.

The Utilities SPDR (XLU) was featured on March 1st as it reversed its downswing with a short-term breakout. XLU went on to record new highs on Monday-Tuesday, but became overbought after a 10% surge in eight days. We do not need a momentum oscillator to figure this out. New highs are bullish and affirm the uptrend, but there is no setup, especially after becoming overbought.

The Agribusiness ETF (MOO) and Infrastructure ETF (IFRA) are also in uptrends similar to XLU (wide rising channels with whipsaws in the Trend Composite). MOO recorded a new high over the last few weeks and IFRA is near a new high. I do not see any setups on these charts. Just choppy uptrends that have yet to bend.

The Aerospace & Defense ETF (ITA) is also in an uptrend after a recent breakout and this ETF was covered on Tuesday.

WatchList for Pullbacks and Oversold Conditions

There are a number of ETFs on my watchlist for potential pullbacks within their uptrends. These include the energy-related ETFs (XLE, XES, FCG, DBE), the steel related ETFs (XME, SLX) and many of the commodity-related ETFs (DBB, CPER, COPX, GLD). Even though these ETFs are in leading uptrends, volatility is well above average. Sometimes the pullbacks are so short and fast that oscillators using 10 or more periods for their settings lag. We can still use retracements to identify potential reversal zones. For example, a 33-50% retracement would mark a potential reversal zone.

The DB Base Metals ETF (DBB) is a case-in-point as it surged some 28% from mid December to early March and then fell 8.4% on Wednesday. The Momentum Composite is not oversold, but DBB is clearly short-term oversold after such a drop. While I expect volatility to remain high, pullbacks and oversold conditions represent opportunities to trade in the direction of the bigger trend, which is still up for DBB.

The DB Energy ETF (DBE) fell 11.2% on Tuesday and the Momentum Composite dipped to 0. Technically, the Momentum Composite needs to hit -3 or lower to become oversold. However, a double digit decline from new highs can also be considered oversold. Personally, I would rather see a controlled pullback that forms a tradable falling flag or wedge, but the market would laugh me right out of the house with this desire. Volatility is through the roof so we cannot expect a “nice” controlled pullback. We have to take what the market gives us.

The next chart shows the DB Agriculture ETF (DBA) with a small bull flag the last four days

Learning What to Ignore

Learning what to ignore is a big part of trading and analysis. For example: I ignore short-term bearish setups and patterns when the bigger trend is up. I prefer to trade in the direction of the bigger trend and therefore only look for bullish setups and patterns. The Gold SPDR (GLD) forged an island reversal yesterday as it gapped up on Tuesday and then gapped down on Wednesday in the same area. Tuesday’s bar is an island with gaps on either side. This pattern is in all the books, but I am not sure how reliable it is as a trading signal. In addition, GLD is in a long-term uptrend and this reversal is basically a one day decline. One day does not a trend make. As with DBB and DBE, GLD is actually short-term oversold after a 3% decline in one day.

These ETFs were covered on Tuesday:

Link to Tuesday’s report.

Investment Themes Going Forward
Oil, Wheat, Soybeans and Copper
Composite Breadth Model
New Lows Expand
10-yr Treasury Yield
Regional Bank ETF (KRE)
Semiconductor ETF (SOXX)
Materials SPDR (XLB)
Cybersecurity ETF (CIBR)
Aerospace & Defense ETF (ITA)
Clean Energy ETFs and Clean Energy ETF (PBW)
Strategic Metals ETF (REMX)
Uranium ETF (URA)
Gold SPDR (GLD) and Silver ETF (SLV)
Oil and the Oil & Gas Equipment & Services ETF (XES)

You can learn more about my chart strategy in this article covering the different timeframes, chart settings, StochClose, RSI and StochRSI.

Thanks for tuning in and have a great day!

-Arthur Hill, CMT
Choose a Strategy, Develop a Plan and Follow a Process

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