Sentiment continues to show some of the most bearish readings we’ve seen since the 2022 bear market began. The AAII, which is a survey that asks investors if they are bullish, neutral or bearish 6 months out, just gave us the lowest reading of bulls since the October low.
Recently, only 24% of those surveyed are expecting bullish results over the next 6 months. Compared with the March low in 2009, this is not too far off that reading, which came in at around 19%.
When we look at the options market, we are seeing a similar rare pattern that has only occurred two times in the last 16 years. This is when we see an outsized ratio of puts being bought while the market is in an uptrend.
Regarding the put/call ratio, any reading over one signals that more puts are being bought over calls. A reading over 1.1 is reasonably rare, which I would consider a fear spike. What you’ll notice is that fear spikes occur mostly in downtrends, and culminate around the lows. The tan regions show multiple fear spikes occurring while the market is in an uptrend (2013, 2017, 2022). Each instance prior saw higher stock prices before a correction began.
Rarely do we see the market rewarding a crowded trade. Even when that trade makes the most sense. In order for a setup to go lower, we need to see sentiment reset. There is a high level of bearish bets right now, and these will likely need to unwind if we are going lower.
Interestingly, this lines up with what we have been saying for the last 3 weeks here, which is summarized in the most recent YouTube video below.
We have been raising large sums of cash throughout late November/early December in preparation for a volatile month. The volatility has only increased the number of bearish bets in the market as many stocks approach oversold conditions again. We believe that the market is setting up for another rally, which should last through early January.
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Whether we drop to new lows, or continue higher is yet to be seen. There are some markets in the US and abroad that have clean setups to new highs, which we’ve discussed here and here. This would certainly be the contrarian perspective going into 2023, which is worth acknowledging. However, the global central banks went on an aggressive rate hiking campaign while shifting global trade dynamics are exacerbating inflationary pressures worldwide. This is happening while we are experiencing drastic decelerations in key tech sectors, which we discussed here. So, we are not married to a thesis, and are ready to shift in either direction once we get clear signals. We believe the biggest risk that investors face going into 2023 is thinking they know what will happen and not considering there is more than one possibility.
In conclusion, we believe there will be a Christmas Rally of sorts as the probability favors a move higher as we enter 2023 into the first couple of weeks of January. Both the market internals and sentiment have reached a level of bearishness that rarely leads to a prolonged drop. Look for this to reset before we go lower.
Regarding the long-term narrative, instead of leaning into a thesis, we prefer to let price action determine whether we hedge, or leverage our portfolio to the long side. This neutral stance has been rewarding for us as an all-tech portfolio. As of now, we are leading our all-tech peers and our audited results will be out in Q1 of 2023.
Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
On October 13th, within the first 30 minutes of the trading day, we removed half of our hedge and went on a buying spry at the I/O Fund, notifying our advanced premium members of our every move. Our broad market work was suggesting a buyable low was likely, and since then, the patterns we are seeing off this bounce is suggesting that it could be more than another bear market bounce.
The below clip is the first part of our weekly webinar from last week. We dive into what various markets are suggesting about the bear market potentially being over. Each week we look at new information so that we can stay on the right side of the trend. We then go into various tech stocks that we are either buying or looking to buy.
Summary: for well over a month we have been pointing out the complex bottoming process that has been unfolding. Global markets like the Australian XJO, Canadian TSX, and Japanese Nikkei appear to have bottomed before the U.S. markets, and are also suggesting that they want to make one more push to new highs in the coming months. Also, the German Dax and French CAC 40 have broken out of their bear market trend lines, which further suggests that a bigger move higher is underway.
These are markets from different regions of the world all suggesting a meaningful low could be in place. This is accompanied by many of the boring value names in the U.S., like JP Morgan and Caterpillar who are nearly between 30-45% off their lows. These stocks, like many we track, are also suggesting that they could make a run to new highs in the coming months. This is clearly showing up in The Dow Jones Industrial Average. It is actually closer to making a new high than new low, while comfortably above its 200 day moving average.
The reason I am pointing this out is because big trends, like the ones we saw in January and September of 2022, only occurs when all markets are working together and pointing in the same direction. This is simply not happening right now. Instead, we seem to have more markets and stocks pointing higher, with new leadership taking hold.
While some tech names could make new lows, we believe many stocks will make higher lows. Furthermore, there are some tech names that we have identified that are +40% off their lows, and bottomed in May of 2022. We believe choice tech names will continue to lead but it will not be like the stocks we have become so accustomed to in the past.
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Last week, the market went through one of the largest intraday swings since the bear market began in 2022. Since then, we have reclaimed that high. The question is: what does this mean for the market in the long term?
How the Chaos Began
It started with the FED. They indicated they are now more open to pausing interest rate hikes, which sent markets soaring. The Federal Open Market Committee (FOMC) announced that, instead of reacting to only the latest inflation numbers, they will take in the “cumulative effect” of all their rate hikes.
They further acknowledged that the aggressive actions they’ve taken to combat inflation need time to play out. In other words, it remains to be seen whether they will they be seriously damaging, ineffective, or somewhere in-between. This startling self-awareness implied that the FOMC may not need to aggressively raise rates until the effects of their rate changes are truly obvious.
The market jumped 1.5% on this announcement, as pundits began to suggest a pause was insight.
However, in the speech that followed, Jerome Powell halted bullish emotions. He acknowledged that inflation has not come down as expected, even though supply chain issues that plagued most of 2021/2022 have been resolved. But he called a pause “very premature”— there’s still so much further to go, both in how high the rate could go and in the duration that they need to stay in the stratosphere.
And so, the press conference led to a plunge in the S&P 500, which closed down -3.4% from its high earlier in the day. It became the worst sell off on a FED-day since January, which has led to a retrace of most of the bounce from the October 13th low.
What Happens Next
You might assume we should brace ourselves for a new low in the S&P 500. That would be the prevailing trend preceding every FED meeting this year, but the market isn’t operating in a vacuum, and when you look outside of the S&P 500, a different story continues to emerge.
While some FAANGs and tech darlings, like TSLA, continued lower, many sectors and global markets continued higher. We’ve been trained for over a decade to follow tech, as it will lead the market. However, a seismic shift is occurring in real-time, as new leaders are being minted. The bond market was signaling to anyone listening that this FOMC meeting was different, as the complex bottoming process we have been discussing for weeks continues to build.
This shouldn’t be a surprise to our regular readers on Seeking Alpha. Here’s what we’ve been saying:
“…more and more signs are pointing to a bigger trend reversal underway.”
“…global markets did not follow the S&P 500 to new lows last week. Instead, they are signaling that a new push higher is likely to follow.” new push higher is likely to follow.”
“…the last time we saw these patterns was in mid-June, just before the market moved up 18% in less than 2 months…”
Those predictions, by the way, were all within the past month.
Value is a Major Indicator of the Next Upward Swing
The Big Five tech companies, also known by the acronym the FAANG, are having a rough time, especially Facebook (where thousands are being laid off), and Amazon and Google, which hit new lows, most people ignored what the rest of the market was saying.
Last week we discussed how boring Caterpillar and JPM Morgan have made their first higher high, as they are closer to making all-time highs than lows. This week, we will continue with theme from a broader perspective.
The DOW
The oft-ignored Dow Jones Industrial Average (DJI) has just given us a clean and clear 5 wave pattern off its late September low, while also reclaiming the 200 day-moving average. Not only did it bottom before the NASDAQ and S&P 500, but this 5 wave pattern suggests a much larger trend is developing. Translation: If the next pullback holds the low, and we can breakout to new highs, I see the Dow Jones powering to new all-time highs in the coming months.
This is not only limited to U.S. value stocks. Global markets are also setting up for a bigger push higher. The French CAC-40 and German DAX have recently broken out of their bear market down trends. This is in light of Europe facing all the problems the U.S. is facing currently facing with inflation, on top of a serious energy crisis.
The Canadian TSX as well as the Australian XJO have broken out of their bear market trend lines. Interestingly, these too markets appear to be setting up for a run the higher highs like the Dow Jones.
The reason I am mentioning this is because really big trends occur when all markets are moving in the same direction. While tech and some FAANGs have a setup to go lower, the rest of the market looks like it is setting up to go higher. It’s important to track these markets in order to get clues on when bottoms (and tops) are developing. A bottom never happens when everyone is expecting it, and it almost always happens when sentiment has reached a bearish extreme.
Transportation Is Having a Bonanza
The transportation sector has historically been a leading indicator of America’s economic growth, and therefore it often leads the stock market.
The Dow Jones Transportation ETF (DJT) is also exhibiting relative strength compared to the broad market. While the Tech heavy NASDAQ-100 is about 9% off its lows, and the S&P 500 is 12% off its lows, DJT is over 16 % off its lows.
Also, like the Dow Jones, it has just completed a 5 wave pattern off the low, suggesting that a bigger rally is likely.
If the next pullback can hold the low, and then turn back above to make a fresh high, it will be signaling that a major low was put in as we move into the heart of a new rally.
The Bond Market Called the FED’s Bluff
The FOMC announcement triggered an odd reaction in a sector few were paying attention to: bonds. The further one gets on the curve, in our experience, the less of an effect FED decisions has on rates; instead, growth and inflation expectations affect them more. After every hawkish policy decision this year, we have seen rates go higher, as long duration bonds hit a fresh low.
Last week, we discussed how bonds were setting up for a multi-month rally. This week we will acknowledge the very important fact that bonds not only failed to make a new low after the last FED speech, but they have since reclaimed the high on FED-day. This is significant, as the bond market is pricing in inflation and rate hikes, and signaling a low in bonds.
As bonds catch a long-term bid, rates will only go lower. This will force many beaten down tech stocks, which are simply long duration assets, to get repriced. This will be a tailwind for tech, and we believe today was the beginning of this repricing.
In anticipation of favorable repricing, coupled with tech’s beaten down valuations, we have been building key positions with real-time trade alerts sent to our premium subscribers.
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Market Levels
Reminder: the market rallied about ~12% just on a rumor of a potential pivot by the FED. Regardless of whether you believe we had it, the market definitely sold the news, and failed to make a new low. Not only that, but the S&P 500 reclaimed the 3912 level which was the high going into the FED speech. This is significant, as it is the first FED high the market has taken back in 2022.
With the divergences we have been talking about for weeks, if we do see continued volatility, it will likely be setting up a buyable low as we setup for a larger rally in the coming weeks.
The S&P 500 is not as clear as the Dow Jones. Like DJT, it completed 5 waves off its October 13th low, but it did so in a messy fashion. There are two primary probabilities: either the S&P 500 will make a new high in 2023 OR will instead play out a larger degree bear rally. If the next pullback can hold the low, then turn back and make a new high, I will be leaning towards the S&P 500 seeing new highs into 2023.
This would occur in large swings and likely take us back to 4300 SPX. It would be the scenario where some stocks and markets make new highs, while others do not. However, what is important to understand is that when you combine what rates, the dollar, global markets and many value stocks are telling us, it is that a large rally of some kind is under way.
What’s Coming— And When
The potential for some stocks to make a new low is present. However, the larger setup is for stocks to keep pushing higher. Short of a black swan event, we think most of the risk over the intermediate to long-term time frame is up — but the FAANGs do not appear to be leading, as we have been accustomed to expect. However, weakness in these companies does not seem to be signaling weakness across the market. As long as rates hold their high, and many of the value stocks that are well off their highs hold, I see any additional volatility as a buying opportunity.
Regarding tech, not all companies are equal. One of the strongest companies in the market, is a well-known tech name, bottomed in May and is nearly 40% off its lows. While we will likely not see an all-encompassing tech rally, we do believe some names are setting up to be new leaders. The prices we are seeing, we believe, will pay off handsomely in the coming years.
Who’s ready for it?
Every Thursday at 4:30 pm Eastern we provide our Premium Members with a weekly market webinar where we discuss the stocks we’ve entered and exited throughout the week, plus stocks that are about to break out and our buy plan. The information from our weekly webinars have been used to successfully hedge our portfolio multiple times in 2022, as well as build positions at key levels. When we buy positions, sell positions or hedge the market, real-time trade alerts are sent to our Premium Members plus we offer a fully managed portfolio including details on allocations.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
When we see divergences building, more times than not, it’s the warning sign of a trend change. We are seeing this now across bellwether stocks, varying sectors, and global markets. Many risk assets as well as global markets did not follow the S&P 500 (SPY) to new lows last week. Instead, they are signaling that a new push higher is likely to follow.
Divergences are important to track. There is always a leading market that can provide advanced warning that a top or bottom is ahead. For example, from the COVID low in 2020 through February of 2021, all major global indexes were moving up together. When you see an all-encompassing trend, it tends to be a powerful one, much like we saw into early 2021.
China then topped in late February and began making a series of lower highs, while the rest of the global market continued higher. One after the other – Australia, Japan, Germany, etc. – they all topped throughout 2021, while the U.S. markets continued higher. This was a warning sign that the first deep correction in the S&P 500 was imminent since the COVID lows.
Source: I/O Fund
Today, we are seeing the same pattern play out, yet in reverse. Japanese markets bottomed in March, followed by China, Australia and now Germany.
Source: I/O Fund
Furthermore, we are seeing multiple key sectors within the U.S. not follow the S&P 500 down to a new low last week. Transportation stocks, High Beta and Small Caps have been leading the markets since 2021, and last week, when the S&P 500 made a new low, these risk-on markets made a new high.
Source: I/O Fund
These types of patterns tend to signal a trend change is brewing. Nothing is guaranteed, but even if the market does drop to a new low, we will only see these divergences grow, setting up for a sharp rally into year-end. I do believe many stocks and some markets have bottomed, and those are the ones that tend to lead going into the next uptrend.
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Recently, along with divergence patterns, we are seeing rare extremes in sentiment. For example, the AAII investor sentiment survey is a reasonable gauge on what retail is expecting 6 months out in the market. Last week we saw a reading of 60.87% of those surveyed had a bearish outlook on the markets over the next 6 months. For reference, the last time we saw a sentiment reading this low was nearly 2 weeks before the March low in 2009. It’s also one of the highest readings in bearish sentiment in the survey’s history.
Source: I/O Fund
Even more important, this extreme sentiment was backed up by real dollars last week. According to Jason Goepfert of Sentiment Trader for the first time in history, retail traders bought over 3 times the amount of puts than calls last week.
It’s not only retail that is scrambling to buy insurance for another low. Fund managers have taken their cash position to the highest in 21 years, exceeding all of 2008, 2009 and 2001.
Source: MarketWatch
Markets top with exuberance and bottom in despair. No one really knows if this is a bottom, but what is certain is that the level of despair and bearish bets have exceeded levels that have marked prior lows.
Where Will the Market Go Next
Two weeks ago, we provided succinct risk levels and also provided our expectation that the market looks like it wants to make at least one more low:
“If the coming bounce can break above 3800, then a major low is likely developing. However, once SPX pushes into 3730, the risk will be elevated, as the above structure does not look complete until we get at least into the 3550 range.”
Today, we have met our target, as the market appears to have exhausted to the downside. The below chart is quite busy, so I will take it one point at a time, but we now have a new range as well as evidence that a new uptrend is developing.
Source: I/O Fund
First off, we have been stuck in a downtrend channel since the August high. There have been multiple attempts to break out of this channel, all have failed and led to new lows. Note how we have broken out of the downtrend channel. I circled this move, and it’s also worth noting that we gapped over the channel on heavy volume and are holding it, so far. More times than not, when we see the channel broken, it’s signaling a trend reversal is in process.
Secondly, note the key reversal bar on the day of the low. This is called a bullish engulfing candlestick. It is when a candle stick covers the entire high and low from the day before. What determines if this pattern is strong is how many days does it cover and is it on heavy volume? October 13th covered 3 days prior and was on exceptional volume, which makes this a strong reversal pattern.
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That being said, the price range that will determine a meaningful low being in is SPX 3830 – 3640. Whatever level breaks first will determine the counts above. If we do breakdown from here, the below SPX levels I’m targeting are 3345, 3280. Even if this does happen, the divergences and sentiment are so strong that it will only set up another buying opportunity.
On the other hand, our base case is that we do breakout above the 3765-3830 region. If this does happen, we expect a multi-month rally to take us into year-end.
In conclusion, we are seeing the types of extreme sentiment readings as well as divergences that mark a reversal. We are also seeing the market shrug off horrible inflation data. Since the PPI and CPI numbers came in hotter than expected, the market is up 6.5%. The last time we saw these patterns was in mid-June, just before the market moved up 18% in less than 2 months. Will this market THE low or will it just another bear market rally? Follow me for updates.
On Thursday, October 20th at 2:30 pm Eastern, we will be providing our weekly market webinar where we will discuss recent earnings reports, as well as analyzing specific stock charts. Our goal is to provide context, as well as identify actionable exits and entries for investors. We have used this information to successfully hedge our portfolio multiple times in 2022, as well as build positions at key levels.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
Markets do not top together, nor do they bottom together. It’s critical to find the leading markets for clues on what’s about to unfold. We saw this in 2021 with global markets all topping throughout the year. Today, we are seeing them bottom one after the other.
We’re also seeing this pattern with various risk-on markets. Transports, high beta, biotech, and small caps, all made higher lows as the broad market made one more low. These assets tend to lead us down, which we were seeing in 2021, but they also will lead us up, which seems to be playing out now.
This week, we will look at these patterns, as well as define the current price range for the broad market. Divergences can provide an early warning signal, but unless the market breaks out of key resistance levels, we do not have confirmation of the trend change underway. I detail this for you more below and also feel free to check out my weekly webinars on YouTube where I discuss broad market levels.
00:00 – Stock Market Intro: The Gap Up from the August Downtrend
03:20 – The Price Range That Really Matters
06:00 – Divergences in the Dow Jones Transports, High Beta Stocks, and Financials
08:18 – Divergences and International Markets (German, Chinese, and Japanese Markets)
12:03 – Get more technical analysis. Sign Up for Free Stock Analysis
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Knox Ridley began consulting on portfolios in 2007 and is an experienced growth investor in both bull and bear markets, which is hard to find these days. As the portfolio manager of the I/O Fund, he beat the top-performing funds on Wall Street in both 2020 and in 2021. His real-time trade notifications to premium subscribers have garnered 27 entries with over 100% gains in the last two years. Knox began his career as an ETF wholesaler in 2007 before becoming a portfolio consultant for large RIAs, FAs, and Institutional accounts. He is very keen on macro trends and is trained in Fibonacci Trading, Elliott Wave theory, as well as Gann Cycles. He also uses classical technical analysis to manage risk and identify great risk/reward setups. Knox is known for increasing and decreasing allocations for record-breaking returns.
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Given the extreme FED action this year that has gnarled the stock market, I think it’s important for investors to look at how we got here to draw conclusions on what may be coming down the line. For brevity, we begin the discussion dating back one year.
In September of 2021, the FOMC decided to keep the Fed Funds rate at 0% and continue their asset purchasing at a regular interval, maintaining a loose policy as a result of the COVID panic. They reiterated rapid growth of the economy into 2022, while most members saw no need for a rate hike in 2022. Some members disagreed that a new tightening cycle would need to be started in 2022, but it was believed that it could be at a slow and tapered pace.
Interestingly, real-time market data related to inflation was flashing signs that inflation was becoming a concern. Here are some examples of data points that contradicted the FOMC’s policy decision at the time:
The NAHB Index, which tracks the sentiment within the home builder’s sector, saw a 160% increase from the COVID low into the September meeting.
The Case-Shiller Home Price Index was showing a ~25% increase in nation-wide home prices. It further showed the highest YoY reading in its history in July with a greater than 20% increase.
The Bloomberg Commodity Index was up 64% since the COVID low into that September, 2021 meeting. This was the highest reading since July of 2015, and also marked one of the steepest increases in terms of rate of change in the Index’s history.
Crude oil was up 47% in 2021, going into the meeting. It was also well above the pre-COVID levels.
The M2 Money Supply was up around 35% since the COVID low going into the September meeting. The M2 layer of the money supply measures the amount of liquid cash in the system, and historically accounts for inflation within an economy.
The S&P 500 was up over 100% from the COVID low going into late September of 2021.
Even the monthly CPI data, which has a built-in lag to some of its metrics, was suggesting inflation was becoming a problem. In February of 2021, the YoY CPI print came in at 1.62%; one month later, it read 2.62%. In September of 2021, it was at 5.3%.
So, what happened, and how could a team of the brightest PHDs, Bankers and Financiers that makes up the Federal Open Market Committee (popularly known as the FED) miss the inflation signals and raise rates so late in the cycle?
The standard policy for central banks is that at the first sign of inflation, they begin a slow and steady pace of rate hikes. For example, in 2004, the FED began their tightening cycle once the YoY CPI print exceeded 3%; in 1999, they began to slowly tighten once it moved above 2%. Even the current Fed Chair, Jerome Powell, started hiking rates in 2017 with inflation around 1%.
In our August webinar, ”This is Still a Warning Sign,” we warned that market risk was high, and that a sharp pullback was ahead. I also mentioned the market was setting up for a reversal going into the CPI print in September, here. Follow me on YouTube here or sign up for the I/O Fund free newsletter to be emailed the weekly webinar.In our August webinar, ”This is Still a Warning Sign,” we warned that market risk was high, and that a sharp pullback was ahead. I also mentioned the market was setting up for a reversal going into the CPI print in September, here. Follow me on YouTube here or sign up for the I/O Fund free newsletter to be emailed the weekly webinar.This is Still a Warning Sign,” we warned that market risk was high, and that a sharp pullback was ahead. I also mentioned the market was setting up for a reversal going into the CPI print in September, here. Follow me on YouTube here or sign up for the I/O Fund free newsletter to be emailed the weekly webinar.
Despite the numerous market indicators pointing towards growing inflation pressures in September of 2021, the FOMC ignored the signs, and instead continue to press their loose monetary policies. They ultimately waited a year after inflation showed up to begin addressing it, putting them much farther behind the curve than investors are used to.
Just over one month after the September 2021 meeting, the FOMC was forced to reverse course. Marking the second sudden policy shift in Jerome Powell’s tenure. As we now know, inflation was not transitory, forcing the FOMC to embark on the steepest rate hike campaign since Paul Volker raised the Fed Funds rate to 20% from a 3-year average of 11.2%.
Rather than engineer a soft landing, the FED did the opposite by raising rates a year too late. What resulted was an aggressive increase and the worst stock market on record in nearly 50 years.
One year later – Inflation is Down, the FED is Up
Fast Forward one year into the recent September, 2022, FOMC meeting, and the same indicators were clearly showing a notable reduction with inflation…
1) Commodities have collapsed, and continue to push lower. Copper prices are down ~30% from their high, while lumber prices have fallen back to pre-COVID levels. Most importantly, Crude Oil is about 16% below its pre-Russia/Ukraine war level, as gas prices declined every day? for 98 consecutive days.
2) Sales of existing homes in August declined 19.9% from August 2021. Furthermore, the Case-Shiller home Price Index showed the largest MoM decline in home prices since 2011.
3) The National Association of Home Builders (NAHB) Index fell for 9 consecutive months and is now below the 50. Anything below 50 is a contraction. The president of the NAHB, Jerry Howard, went as far to state that “we’ve given birth to a housing recession.”we’ve given birth to a housing recession.”
The last time we saw the NAHB Index below 50 was briefly around the COVID low and then again in 2014. In fact, the last 9 months saw the 3rd steepest % decline in the NAHB Index since 1990.
4) The M2 money supply is one of the most important indicators of inflation, and is the layer of the money supply that tracks liquid money in bank deposits, CDs, Mutual Funds, etc. In other words, the money that is ready to be used in an economy. After seeing a 35% increase post-COVID, since February of 2022, the M2 money supply has been negative to flat.
Ultimately, inflation is a monetary phenomenon. The more money in the system chasing the same goods, inherently means goods will increase in price. Following the M2 money supply is the most effective way to track if inflation is growing or shrinking.
The list can be extended into Producer Price Indexes and Manufacturing Costs consistently surprising to the downside. Inflation data does not have a lag built into its calculations, and looks at real-time market information, is signaling a noticeable change in trend with inflation pressures. Yet, just like in 2021, the FOMC appears to have a disconnect between inflation and its policy, except in the opposite direction.
The market was expecting a 0.75% rate hike this round, which it got. What it was not expecting was for the FOMC to raise its target rate, extend the duration for rate cuts, and claim that inflation is still out of control. They further spooked the market by stating that more pain would be needed to bring inflation back to its 2% target. This was backed by lowering their economic growth forecasts for this year, down to 0.2% from 1.7% in 2022, and 1.2% from 1.7% for 2023.
This meeting caught the market by surprise, triggering a sell-off that has pushed the S&P 500 to new lows in just under 2 weeks. I provide weekly webinars that discuss what I/O Fund is buying and selling. We also have a proprietary hedging signal that we monitor in real-time. Following the free analysis, Why The Next 2 Weeks Could Determine The Rest Of 2022 Why The Next 2 Weeks Could Determine The Rest Of 2022 we hedged going into the CPI number for a nice gain in a tough market. That analysis dated September 8th stated:
“Historically, this grid tends to accompany the C wave down in a bear market. However, in 2022, the market exhibited a sell-now-and-ask-questions-later mentality, as we saw the S&P 500 decline by 24% and the NASDAQ-100 decline 34% over a 5.5 month period. These are rare moves, and one has to wonder if the worst is priced in – including the global slowdown in growth? I do believe it’s cavalier to assume that at this point, and prefer to let the broad market prove it to me over the coming month. We will remain cautious until then, and respect the Big Risk-Off grid that we are now in.
If we have, in fact, found a meaningful low, we would not only need to see the S&P 500 give us that 5th wave up, but we would also need to see rates, the USD and oil move down or sideways. Bull markets do not happen in vacuums and tend to be supported by various markets firing in unison. As of today, this confluence of inter-market dynamics is not supporting a direct uptrend in equities.”
Just like in the September of 2021 meeting, the FED appears to be ignoring market signals about inflation. By ignoring the real-time market data regarding inflation, the markets will once again force their hand, as it always does. The only question remains is what will have to break before they flinch? As stated, we believe it is prudent to wait for the clear reversal before getting too aggressive in equities. This is why our service has hedged the majority of September with real-time trade alerts sent to our Members.
SPX Levels to Watch
The S&P 500 is tracing out what appears to be a 3-wave pattern down from the August high. This is important, because it is not suggesting an immediate breakdown from current levels. Instead, we are seeing extreme oversold conditions that tend to lead to a short-term bounce, at minimum.
If the coming bounce can break above 3800, then a major low is likely developing. However, once SPX pushes into 3730, the risk will be elevated, as the above structure does not look complete until we get at least into the 3550 range.
To further support a bounce, today we saw the broad market make a new low; however, it did so with notable divergences. For one, the VIX did not make a new high, which tends to precede a turn. The market also went down with less stocks making new lows than last week’s low. This was met with the Advance Decline line also not making a new low with price. These are common signs we see prior to a turn.
On the I/O Fund premium site, I provide weekly webinars that discuss what the I/O Fund is buying and selling. We also have a proprietary hedging signal that we monitor in real-time. Following the analysis I provided for free on YouTube last month “This is Still a Warning Sign” and also in this article “Why the Next Two Weeks Could Determine 2022” we hedged going into the CPI number for a nice gain in a tough market and have had a hedge in place most of September.On the I/O Fund premium site, I provide weekly webinars that discuss what the I/O Fund is buying and selling. We also have a proprietary hedging signal that we monitor in real-time. Following the analysis I provided for free on YouTube last month “This is Still a Warning Sign” and also in this article “Why the Next Two Weeks Could Determine 2022” we hedged going into the CPI number for a nice gain in a tough market and have had a hedge in place most of September.I/O Fund premium site, I provide weekly webinars that discuss what the I/O Fund is buying and selling. We also have a proprietary hedging signal that we monitor in real-time. Following the analysis I provided for free on YouTube last month “This is Still a Warning Sign” and also in this article “Why the Next Two Weeks Could Determine 2022” we hedged going into the CPI number for a nice gain in a tough market and have had a hedge in place most of September.
The next premium webinar will be on Thursday, October 6th at 4:00 pm Eastern where I will discuss how I plan to trade the broad market signals discussed in this article plus new information on an important time factor in mid-October which I believe is lining up with the Q3 earnings season. Learn more about Premium I/O Fund Services here.The next premium webinar will be on Thursday, October 6th at 4:00 pm Eastern where I will discuss how I plan to trade the broad market signals discussed in this article plus new information on an important time factor in mid-October which I believe is lining up with the Q3 earnings season. Learn more about Premium I/O Fund Services here.Premium I/O Fund Services here.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
For most of August, we have been providing free webinars in prior blog posts outlining an “imminent pullback.” You can access these here, and here. In this article, we will discuss key levels that must hold in order to maintain a long-term bullish bias. We also discuss why a direct drop to new lows may not play out, even if the bear market resumes. We then discuss the supporting markets that need to work in unison with equities before we can see a meaningful uptrend resume.
There is a popular saying on Wall Street – equity markets are discounting machines. In other words, equities are looking 6-9 months into the future to create prices today. Because of this fact, we regularly see market scenarios that sometimes do not make sense.
For example, in April/May of 2020, the high-frequency data was literally off the chart. We were seeing record unemployment, as well as PMIs falling off a cliff. This was coupled with companies in the service sector reporting losses that were nearly unprecedented. Yet, the market powered higher as this data continued to come in week after week. Ultimately, the market was right, as the US economy saw a relative recovery, and avoided the worst-case scenario.
We saw this phenomenon again last month. The June CPI number hit another 40-year high, beating consensus expectations. This was followed up by the Producer Price Index beating estimates to the upside, which implies rising inflation into the future. We then saw bank earnings come in mixed to bad, kicking off the feared earnings contractions brought on by over a year of real earnings seeing MoM declines due to wages unable to keep up with inflation. On the back of this bad news, the market failed to make a new low, and instead rallied nearly 700 points into late August.
When we see the market rally on bad news, what the discounting machine is telling us, is that all the bad news that is currently known, and can be modeled, is now priced in. We tend to see markets bottom in a place of despair, with most market participants certain we are going lower, while markets tend to top into euphoria, where most market participants are certain we are only going higher.
How to Model Investor Sentiment
The inability to model investor sentiment has been an ongoing issue with economic models for many years. It was one of the primary issues in 2008 when most models failed to see such a dramatic drop. Sidney Winter, Wharton School Professor, stated, “As computers have grown more powerful, academics have come to rely on mathematical models to figure how various economic forces will interact. But many of those models simply dispense with certain variables that stand in the way of clear conclusions. Commonly missing are hard-to-measure factors like human psychology and people’s expectations about the future.”
The only way to truly model investor sentiment is through technical analysis. Market patterns show up time and time again throughout history and across all assets being traded between humans. The art of properly interpreting these patterns can help investors get ahead of big moves.
The market pattern we are currently trying to interpret in real-time is a corrective pattern, which will unfold in 3 legs: A wave down, B wave up, C wave down. The question for the remainder of 2022 is simple – is the current 3 legs of the bear market that bottomed on June 16th the entirety of the correction, or is it just the 1st leg of a much larger correction?
We should know the answer to this question within the coming month. Assuming that the June low was the low, the current uptrend would be developing a new large-degree 5-wave pattern off the low.
As of now, we only have 4-waves. So, in order for this to be true, we need to see the market bottom soon, and then push back above the 4330 SPX level. This would give us a clean 5-wave pattern off the low, which would be wave 1 of the larger 5-wave uptrend developing. Here is a visual to show what this would look like.
If we instead break below 3920-3900, then the odds favor a continuation of the bear market. However, I would not be expecting a straight drop, if this does happen. Assuming that we are currently in a large degree bear market bounce (B wave), there is one major clue that we do have to help us determine where this bear market will take us. The move from the ATH to the June low occurred in a rather straight-forward 3 wave fashion.
Note how the make-up of this larger 3 wave move was 3 down, 3 up, and then a 5 wave move into the June 16 low. If this is only the first leg of a larger bear market, it appears to be in the form of what is called a Flat corrective pattern. If this is true, then there are only 3 Flat Corrective Patterns to consider for an outcome.
Note how in each Flat corrective pattern, the B wave (up) retraces a large portion of the A wave down. If we are in an Expanded Flat, the B wave makes a new high before the final leg drops to new lows. In my experience with Flat corrections, we tend to see the B wave retrace at least to the 61.8% retrace level of the entire A wave, and the B wave tends to be nearly as long as the A wave in time.
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As of today, we have come close to this target in price, yet we have fallen short in time. Playing the probabilities, it is highly irregular to see a Flat corrective pattern’s B wave be so brief relative the length of the A wave down. Anything is possible, which is why we plan to stick with the probabilities until critical supports break. If this is accurate, we are likely more than halfway through the bear market bounce. Once we bottom in the current selloff, as long as we hold the 3720 level, we should then see a 5 wave rally to a new local high into Fall.
Inter Market Analysis
Our economic grid analysis has moved into what we call the Big Risk-Off grid for the first time since 2020. This means that the rate of inflation is slowing along with the rate of economic growth.
Historically, this grid tends to accompany the C wave down in a bear market. However, in 2022, the market exhibited a sell-now-and-ask-questions-later mentality, as we saw the S&P 500 decline by 24% and the NASDAQ-100 decline 34% over a 5.5 month period. These are rare moves, and one has to wonder if the worst is priced in – including the global slow-down in growth? I do believe it’s cavalier to assume that at this point, and prefer to let the broad market prove it to me over the coming month. We will remain cautious until then, and respect the Big Risk-Off grid that we are now in.
If we have, in fact, found a meaningful low, we would not only need to see the S&P 500 give us that 5th wave up, but we would also need to see rates, the USD and oil move down or sideways. Bull markets do not happen in vacuums and tend to be supported by various markets firing in unison. As of today, this confluence of inter-market dynamics is not supporting a direct uptrend in equities.
Bonds
We have talked for several months about how the bond market is not buying what the equity market was rallying on. If we did just to see peak inflation in the U.S., we would then expect the bond market to start trading on the global slow-down in economic data. This would cause a bid under bonds, as the bond market scrambles to lock in high yields as the economy moves towards a deflationary event. However, we are seeing the opposite.
This suggests that the bond market is not yet convinced that inflation is behind us. Until TLT moves past $117.50, the odds remain that rates have not peaked, yet. If rates continue higher, expect volatility to follow, as companies must reprise their future cash flows/earnings due to rising borrowing costs.
The U.S. Dollar
The dollar (USD) has also been a catalyst for volatility in 2022. The USD has seen a sharp uptrend, drying-up international sales and thus affecting revenues. With peak inflation behind us, a FED pivot would likely start getting priced into the USD along with stocks.
Furthermore, The EU just posted the highest CPI and PPI readings sin e the inception of the Euro. Furthermore, Germany, who accounts for nearly 30% of the Eurozone economic output, just reported that consumer costs rose 8.8% vs. 8.5% a month prior. This is the largest increase since 1973, and far exceeds European wage growth of 3.8%. Therefore, the EU has accelerating inflation that far exceeds wages.
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The reason this matters is because the U.S. has potentially seen peak inflation, with data surprising to the downside.
The FED is far ahead of the ECB in terms of rate hikes, which means the EURO is likely to head higher, as the USD starts topping. As the FED reverses course to flight deflation, a loose dollar would be implied, causing a peak in the dollar. We are simply not seeing that yet. This implies that global fears are still present, as investor rush to the safety of the USD.
The Dollar Index, DXY, is hitting a confluence of big resistance on weakening momentum. If we see a strong break above the 45-degree line (1×1 in red) it could spell trouble for equities. As of now, it is holding the resistance, which we now need to see a follow-through to the downside to relieve pressure from equities.
Energy
The Oil market is also looking ready to push to new highs. The global economy is slowing down, making the need for energy less than it was a year ago. However, the crude oil charts look primed to make a new high.
What would cause a push to new highs is yet to be known. However, in the face of slowing growth, it would likely be a catalyst the market is not pricing in yet. Many times, markets provide warnings that a new risk is on the horizon, and if we are to see a new leg lower, it would likely be a catalyst that is not known or being taken seriously.
Potential Catalysts
Next week, we will discuss the most concerning catalyst for the continuation of a bear market in our free newsletter. Here is a secondary catalyst we are tracking:
China/Taiwan:
Taiwan is an island off of the Chinese mainland that was governed independently from China since 1949. China views the island as a renegade province and has repeatedly threatened to force submission to Chinese law and political views. In 2016, the election of president Tsai Ing-wen, was a statement that the people wanted a further divide between Taiwan and China. Tsai instilled a movement of separatism and nationalism, which goes against the vision of the Peoples’ Republic of China, which continues to build today.
These tensions have continued to escalate into 2022 where they have reached a boiling point. We have seen numerous threats from China, coupled with Taiwanese leaks that seem to be preparing their citizens for war. Whether this will escalate or not is yet to be seen.
However, like Russia’s military drills in the region grew just before an invasion, China’s military drills continue to grow in the Taiwanese region as well. It also does not help that Russia and China have engaged in joint military drills recently, as the US announced that it has sent two warships to the Taiwan Straight.
If we do see an invasion, expect crude oil to move to new highs. This will put pressure on global oil markets, which will likely push inflation concerns higher, causing bonds to continue their decline as the USD is bought as a flight to safety.
Conclusion
The biggest tell will come from the US equity market over the next month. If we can get that 5th wave up, the US market is leaning towards the low being in, implying that the catalyst for a C wave lower is unlikely. On the other hand, if we break below 3975, the equity market is telling us that something is not right. The great discounting machine will be discounting something the rest of the market is simply not aware of until it is too late.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
In early July, the broad market failed to make new lows even despite bad news. The CPI print came in at a 40-year high, followed by the producer price index surprising to the upside. This told the market that inflation was still an issue and would likely be into the near future. This was then followed by mixed banks earnings, as reports of a looming economic slowdown and run-away inflation was starting to show up in earnings.
Yet, the S&P 500 continued to trend up on this bad news, which is a pattern we typically see around meaningful shifts in trends. Once the market starts going up on bad news, it’s telling us that what is known is priced in. What followed was a swift move that caught many investors off guard. Due to having ample experience in weathering pullbacks, we built key positions in the month of May and June as we felt the prices were “good enough” based on our time horizon.
With that said, outside of building key positions, we have also been warning our readers for the past month to be cautious. We still do not have confirmation that the bear market is over and we will have better opportunities to accumulate if this confirmation starts to develop.
What we want to see to start building this case is: 1) We only have a 4-wave bounce off the June 16th low. We want to see this bounce make one more high, which would complete a 5 wave pattern; 2) Rates need to confirm a bottom; 3) The US dollar needs to confirm a top.
I believe that the most important of these three occurrences is the first one. Trend reversals tend to develop in 5-wave patterns. If we can get a confirmed 5-wave push off the June low, the odds will start favoring a bigger uptrend is developing over the long-term. However, because the bond market and USD is not lining up with this scenario, investors should be cautious and expect more volatility until they do.
In last week’s broad market webinar, we warned our readers that a pullback was imminent. We also laid out what levels need to hold in order to confirm a new uptrend is forming. We also showed that the bond market is simply not buying what the equity market is, and that the USD pushing to new highs along with equities. These markets are simply not aligned with the current uptrend in equities, and until they are, we will remain cautious.
The below video goes through the levels as well as possible scenarios we could see play out over the coming months…
The Bull Case: we want to see a pullback into the 4165-4020 region. We then need to see the market hold this region, and then turn back up to make one more high. If this happens, we have a clean 5 wave push off the June low, and a important evidence that a new uptrend is developing into 2023.
Since the last video, the S&P 500 pulled back just over 4% in three trading days, and is currently in our target zone. We need to see buyers push the market above SPX 4330 to confirm that final 5th wave. We should know in the next two weeks if the above scenario is in play.
The Bear Case: if we fail to make a new high above SPX 4330, and instead turn back down below the 4020 region, what the market is telling us is that 2023 is likely setting up for another leg down in the current bear market. If this does happen, we will be looking for one more large push higher into the Fall before we prepare our portfolio for this outcome.
No matter what scenario plays out, we expect around a ~10% pullback in the coming weeks, which should be followed by one more large push above SPX 4400 before the next leg lower begins. Here is an updated chart with the two scenarios we are tracking (blue is the bull case and red is the bear case).
Supporting Markets – Rates, USD
These are the charts that we have been tracking weekly. They are also the primary culprits behind the downward pressure on equities. Runaway inflation has forced the bond market to sell bonds due to a fixed yield well below the current CPI prints. Bonds do well in deflationary environments and poorly in inflationary ones. As bonds go down, rates go up, forcing equities to reprice their future projections.
Also, as the FOMC aggressively raises rates, the USD becomes scarcer, thus making it stronger. With the level of international exposure many US companies have in their revenue, this makes buying US goods more challenging internationally. Higher rates and a strong dollar are not great for equities, especially risk assets, hence the selling. So, we need to see a reversal in these two charts, specifically in order to confirm a new uptrend is developing.
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The equity market has rallied in a big way on the back of inflation data surprising to the downside for the first time in July 2022. This was followed up by several data points, such as, the producer price index coming in lower than expected, coupled with on-going housing data and manufacturing data that also suggests inflation may have peaked.
This was accompanied with a less hawkish tone from Jerome Powell in July, as the ECB started to increase its hawkish tone regarding soaring inflation in Europe. By all measures, it appears that the equity market is pricing in all the current inflation data, as well as a coming FED pivot. However, the bond market isn’t buying what the equity market currently is.
If peak inflation is behind us, and a FED pivot is likely to follow. Then the on-going slowdown in global economic output should take center stage.
The above chart is a visual representation of US economic growth on a MoM basis. As the economy continues to slow, bonds should become more attractive, especially considering we are seeing attractive yields accompanied with the potential for peak inflation. Yet, since August 1, the ETF that tracks long duration government bonds (TLT), is down over 7%.
This means that the bond market is selling bonds, not buying them. Furthermore, you would expect the dollar to put in a top while the Euro puts in a bottom based on the rhetoric we are hearing from the central banks.
The dollar Index (DXY) is doing the opposite, as it is less than 1% away from making a new high. This is not the kind of action you’d expect to see if we were really past peak inflation and the FED was looking to pivot.
In Conclusion
We follow price, and if the broad market can give us a 5 wave push over the coming weeks, we expect bonds and the USD to get in line as we further base into the fall. These patterns tend to precede developing fundamentals, which is why it’s important to be aware of them while also following the price structure in the broad market. These markets are warning investors that are paying attention to not get too excited, yet. No matter what scenario plays out, we do believe there will be a better opportunity to get aggressive on the long side.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
Apple Inc. (NASDAQ:AAPL) became the most valuable company in the world through creating and dominating the smart phone/mobile microtrend. As the majority of the global community went from zero smart phones to it becoming a necessity in their lives, Apple became the most valuable company in the world. However, like all trends, eventually it reaches the point of saturation. Instead of hypergrowth, we see competitors fight over existing customers on lower cost goods as revenue growth moves into a more consistent yet slower rate of change.
Apple epitomizes what it means to be both a good value stock and a good tech stock with its strong margins, outsized cash flows, stable balance sheet, and a loyal base of customers supporting the brand.
Apple has been very consistent with its margins and cash flows. The company's operating margin of 30.82% and the net profit margin of 25.71% are excellent, while most tech companies are currently struggling with the bottom line. It also has an outstanding free cash flow margin of 26.37%. The company has also been shareholder-friendly since it consistently repurchases shares.
We have not owned Apple because it is simply not involved in any of the new tech microtrends that will likely give us the next Google (GOOG, GOOGL), Apple, or Amazon (AMZN). However, this does not mean that Apple does not deserve a place within a portfolio.
Apple is an outsized beneficiary to passive investing. For those that do not want to pick stocks, and instead just own the index, Apple takes up the largest portion of this money. For example, if you don't want to own tech companies and instead want simply exposure through Technology Select Sector SPDR ETF (XLK), 23.47% of that money goes to Apple.
In regards to the S&P 500, which is the most passively owned index through various mutual funds and ETFs, Apple currently takes up 6.85% of the weighting in the S&P 500, and therefore gets 6.85% of funds going into the S&P 500. This is more than UnitedHealth Group, Berkshire Hathaway (BRK.A, BRK.B), Johnson & Johnson (JNJ), Nvidia (NVDA), and Exxon (XOM) combined!
Because of how its history of share buybacks, healthy Free Cash Flow, and its very large market cap, it remains a darling within institutional funds that are managing billions. In fact, as of June 30th, 16.07 billion shares outstanding are owned by institutions. This means that roughly 98% of all shares outstanding are owned by institutions.
Even though it is not in the forefront of AI, Machine Learning, Cloud or Big Data, it is uniquely setup to capture an outsized portion of passive investors' funds as well as institutional funds. Therefore, it is difficult to imagine the broad markets making new highs without Apple.
Technically, Apple has exhibited a level of relative strength in this bounce that is what you want to see in confirming a broad market trend reversal. It has reclaimed the $145 resistance level, which is a key supply zone to take back. Whether it will hold it is the question?
The fact that Apple has reclaimed the $145 level is a show of strength, regardless of the weakness in the momentum. If the other FAANGs were showing the level of strength APPL is right now by reclaiming key resistance levels, that would be encouraging that a meaningful low is underway. However, we are just not seeing that right now.
Google
We recently wrote about how Google (Alphabet) is our second favorite FAANG. In a cookie-less world due to Apple's notable change to its IDFA, owners of 1st party data, like Google, are setting themselves up to further dominate. This catalyst, coupled with its positioning within the AI microtrend, is the reason why it reserves a position within our portfolio.
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This also lines up with the technical chart on a long-term basis. Google is the healthiest chart amongst the FAANGs, as it is comfortably above its critical support zone at $1800. As long as any additional weakness is seen here, above this critical support suggests that GOOGL is one of the FAANGs that is likely to make a new high.
However, over the next month, it appears that Google is tracing a bear flag pattern. This is a common pattern that we see in 4th waves, which suggests we need one more wave to complete the 5 wave pattern in Google's drawdown.
Netflix
NFLX is another FAANG that we believe has a higher probability of making a new high in the next growth cycle than most believe. While market was focused on NFLX reporting a subscriber miss of 200,000, it failed to recognize that NFLX is on track to monetize around 100 million new subscribers who are sneaking onto the platform through shared passwords. We wrote about this extensively in a recently report, and as a result has entered into our matrix of potential positions to own going into the next growth cycle.
We believe NFLX is undervalued based on where this monetization will take its revenue in the coming quarters, and this is showing up in the chart on a long-term basis. However, over the next month, Netflix looks to be tracing a bear pennant pattern/triangle pattern. These are common in 4th waves, suggesting one more push lower to complete the drawdown.
Microsoft
Microsoft (MSFT) is one of the FAAMGs that we believe will continue to exhibit dominance into future tech trends. It is one of the leaders in the on-going cloud trend, and is also setting itself up to lead in edge computing and machine learning. We believe Microsoft has multiple catalysts to maintain its growth, which is why we own it within our portfolio.
We think Microsoft is the best risk/reward mega-cap tech stock due to its firm foundation in the cloud and its diversified cloud products. It's also positioned for outsized growth due to its exposure to secular tailwinds such as Artificial Intelligence (AI), Machine Learning (ML), and the build out of the 5G network edge. We think Microsoft will take a substantial share of these markets at the infrastructure level due to its relationships with the Fortune 500 and Global Fortune 2000.
The company's business relationships with Fortune 500 companies, brand image, and wide user base are the moats that will help the company drive revenues in the hybrid cloud, machine learning, and artificial intelligence segments. Microsoft Azure is used by more than 95% of the Fortune 500 companies, which shows the company's dominance across enterprises.
This is also present within the long-term chart of Microsoft, as it is another FAANG that has a high probability of making a new high in the next growth cycle. As long as it critical support holds at $215, this will remain our primary outlook. However, like the rest of the FAANGs, it looks like it is setting up for one more push lower before we can start looking up.
Amazon
Amazon also looks ready to break the $101.50 support zone in what looks like a 4th wave top. The RSI continues to fail under the key bear market resistance at 57. We also have a confirmed Negative RSI Reversal Signal, which is when the RSI makes a higher high while price makes a lower high. This is happening well underneath the bear market resistance of 57 on the RSI. The odds favor one more push lower.
Meta
Meta Platforms (META) is the one stock within the FAANGs that has a high probability of not seeing new highs in the next growth cycle. Fundamentally, the effects of Apple's changes to IDFA has finally caught up with META. We have been warning about this shift in META since early 2020. In short, Audience Network is what allowed META to become the advertising behemoth that it is. Not only was META capturing 1st party data through Facebook, but Audience Network allowed it to capture a large portion of 3rd party data.
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We had also said back in 2018 that we think Audience Network contributed $5 Billion to $10 Billion in ad revenue (the third-party data ad exchange FB uses). Three years later, that's what Facebook stated in their February 2nd earrings call – "we believe the impact of iOS overall as a headwind on our business in 2022 is on the order of $10 billion."
Simply put, the metaverse is simply not big enough to fill this revenue gap. This is showing up in the chart of META. For one, we have a confirmed 5 wave drop from the all-time high. For one, note how the 3rd wave, which is the most powerful move in a trend, happened on peak volume and peak momentum. This is because traders/investors realized that they are on the wrong side of the herd. They sell at any price, creating an intense moment of sentiment. The 5th waves are always on weaker volume and momentum, which is what we are seeing. Here, the shorts always press their luck, exhausting sellers for this move down.
Why this is significant is that the only corrective pattern that starts with 5 waves down is a Zig-Zag pattern. This is 5 waves down, a 3 wave retrace that fails around half way, then another 5 wave pattern down to new lows. If accurate, the next growth cycle will have META making a move back towards $225-$275 before failing.
For this to invalidate, META must reclaim the $330 resistance zone. This is unlikely due to the fundamental problems META now faces.
In conclusion, there are simply too many divergences between Apple's strength and the rest of the FAANGs to signal a meaningful low is in. I think the odds are high that we at least attempt a double bottom, if not a push towards 3500 SPX before we can start looking up. I do believe that if we do see a push to new lows, it will likely be the 5th wave in this correction. So, it should be on weaker momentum and less volume than prior moves. If so, we will continue to add to beaten down tech stocks that primed to become the next FAANGs.
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