Technically Speaking, January 2023

This month’s President’s Letter is dedicated to all of the volunteers that make the CMT Association the global leader in Technical Analysis research, education and advocacy.

I want to give a big shout out and thank you to Jamie Coutts, CMT, CFTe, who served on the Board of Directors from 2016 through 2022. Jamie was instrumental in building our APAC regional presence over these years, having first organized chapter meetings in Singapore – some of the most well attended meetings globally – and then serving as the first Chair of the APAC Committee. Jamie was also a strong proponent of quantitative technical analysis and the study and use of cryptocurrencies, helping to guide the Board in making strategic planning decisions regarding these important and developing subjects. His enthusiasm, professionalism and expertise aided the CMT Association tremendously. That being said, Jamie is still involved in CMT events and remains an active Member, now residing in Australia.

In November, the Board of Directors voted to approve Ananda Bhaumik, CMT as a member of the Board and assume Jamie’s remaining term as Director-at-Large. Ananda lives in Hong Kong SAR and is the Chair of the APAC Committee. He is a Senior Partner with UCAP HK Asset Management and has more than 20 years of experience in wealth management. Ananda received the CMT designation in 2017 but has been practicing Technical Analysis since 1986. Additionally, he brings to the board expertise in Treasury Management, as he also has the Certified Treasury Professional (CTP) designation. Welcome Ananda, and thank you for your service!

Do you have an interest in serving on the Board of Directors, or do you know someone who you think would be interested? The Board of Directors is currently performing its annual board refreshment process, which culminates in a slate of proposed Directors to be voted upon by all Members, like you, at the Annual Member Meeting in June.

The Governance Committee is seeking nominations for the role of Director at Large on the Association’s Board for terms beginning in Fiscal Year 2024. Click here to submit a name to the Governance Committee.

Taking into consideration the experiences and expertise needed to fulfill its mission of strategic leadership and oversight, the Board evaluates nominees in light of the its overall composition, geographic location, skill sets, and diversity. Additionally, a demonstrated commitment to volunteerism is required. Prior participation in Association activities is a great example, such as acting as a CMT chapter chair, serving on one of the various committees of the Association, or volunteering to speak at events.

Check out the article I wrote back in August about serving on committees.

Finally, I want to thank all of the members who have served as chapter chairs in the past or are currently chapter chairs. I’ve organized chapter meetings before and it can be a lot of work, but it is even more rewarding in that you build a great network of CMTs in your area.

If you want to volunteer, send us an email here: admin@cmtassociation.org to let us know and the Association’s staff will help you get involved in the area that interests you.

Downside momentum usually peaks at the end of a decline, as prices cascade into a primary low. On the upside, though, momentum peaks at the beginning of an advance, then gradually dissipates as the advance goes on, and the more powerful the momentum at the move’s beginning, the stronger the overall move; REALLY strong momentum is found only at the beginning of a REALLY strong move: a new bull market or a new intermediate upleg within a bull market. We coined the term “breakaway momentum” in the 1970’s to describe this REALLY powerful upside momentum. The following is a review of what it is and how it is typically generated.

Breakaway momentum (some people call it a “breadth thrust”) occurs when ten-day total advances on the NYSE are greater than 1.97 times ten-day total NYSE declines. It is a relatively uncommon phenomenon; the table at the end of this report shows the 25 times it has occurred since World War II (an average of once every 3 1/2 years). Cyclical bull markets, though, are traditionally heralded by breakaway momentum, so we are hopeful that it will be generated this time around, too.

How is breakaway momentum typically achieved? It’s not easy. Usually, we need three things to happen. First, we need a VERY strong advance at the outset of the ten-day period. Typically, this requires an advance-decline ratio in the area of 2800-500 on the first day, 2500-700 on Day Two, and 2050-1050 on Days Three and Four. This creates a cumulative ratio of 2.69-1, which is well above the 1.97 threshold. The very strong advances on the first two days followed by still-positive breadth on the next two are a formidable achievement, but the next one is even tougher. Markets never go straight up, and the real trick in achieving breakaway momentum is to keep declines limited during the inevitable corrections that occur in any ten-day period (it takes two advances to offset every decline, which is why “good” breadth days of 2-1, or even 3-1, won’t cut it as far as achieving breakaway momentum is concerned). In order to keep declines limited during corrections, the corrections must be minimal; often, this occurs when intraday declines abort before the close, and a big breadth deficit turns into just a narrow one by day’s end. Breadth during the “correction days” (Days 5-6), then, should be no worse than 1400-1700; although this pushes the cumulative ratio down to 1.84, this is a far from insurmountable deficit. The final element needed to get breakaway momentum is a second strong advance during Days Seven through Ten; not quite as strong as the initial advance, but not too far behind it, either. If, for example, the market generates breadth during Days Seven through Ten of 2500-700, 2300-800, 2100-1000 and 1900-1200, the ten-day breadth totals are 21000 and 10400. This generates a ten-day breadth ratio of 2.02 – breakaway momentum!

The real trick in generating breakaway momentum? It’s not a lot of advances; it’s a lack of declines. If the market stages a strong two-day advance, for example, it MUST maintain very positive breadth days for a couple of days afterwards (Days Three-Four and Nine-Ten) to keep the ten-day declines to a minimum. Also, declines MUST be kept to a minimum during the “normal” correction in the middle of the ten-day period; declines can exceed advances during those two days, but not by much or it will be impossible for the market to generate the two advances needed to offset every decline.

TABLE I – BREAKAWAY MOMENTUM SINCE 1945

January 2019 Addendum

The ten-day ratio of advances to declines is used to define Breakaway Momentum. In 2016, however, Mark Ungewitter noted that the 20-day ratio hit an unusually-high 1.80 on March 11 even though the ten-day ratio never exceeded its 1.97 threshold. This was the first time the 20-day ratio had exceeded 1.72 without an accompanying 10-day reading above 1.97.

Given subsequent market action, we now know the 20-day 1.72-plus reading was a “good” signal even though it wasn’t confirmed by the ten-day ratio until July 12th. Accordingly, I have added it to the table – but with an asterisk, both to indicate that it is the 20-day ratio and to differentiate it from the 12 other post-1973 signals which were all generated and noted in real time.

So: We now know that the stock market generates breakaway momentum when ten-day total advances on the NYSE are greater than 1.97 times ten-day total NYSE declines OR 20-day total advances on the NYSE are greater than 1.72 times 20-day total NYSE declines. (Just in case the market decides to generate another 20-day signal without an accompanying ten-day signal.)

Post-BAM Performance

Post-BAM declines/corrections tend to be surprisingly brief and shallow given the amplitude of the BAM-genersting advance. (When the train leaves the station it doesn’t back up to let late-comers get aboard.)

Via and courtesy of @twillo1:

And via and courtesy of Mark Ungewitter:

– Walter Deemer

Crude Oil had a shaky beginning to 2023. The first two trading days of the new year saw Brent Crude plotting a high of 87 and a low of 77.72; a wide swing that was almost over 12% in terms of price. After that, the commodity stabilized and has been steadily rising over the past couple of sessions. However, a top-down exploration of the Brent Crude charts presents a much clearer picture that is devoid of “noise” and lays down a potentially bullish case for the commodity.

A glance at the long-term monthly chart of Brent Oil shows a formation of a large Symmetrical Triangle; from the beginning of 2008 until a breakout in June 2021, this formation took over 13 years to develop. The up move that followed the pandemic lows eventually led to a breakout in June 2021. More importantly, following a corrective retracement, Brent Crude price is seen taking support at the 200-Month MA. It has bounced off of this support twice and the formation of two long-legged candles at the 200-Month MA lent massive credibility to this critical level. The 200-Month MA currently stands at 69.56.

Above is a weekly chart; this looks at Crude Oil from a closer perspective. This chart also explains the interesting relationship between the price and the 40-Week MA in the immediate past. Brent was around $42 when it crossed above the 40-Week MA in November 2020. Since then, until it peaked near $137, it saw a price appreciation of over 240%. During this phase, there were two occasions when Crude took support at 40-Week MA when it was under corrective retracements. The first instance of taking support at the 40-Week MA saw the prices rallying by 35%. The second instance saw Crude rallying by over 83% after testing the support at the 40-Week MA.

It was in August 2022 that Brent slipped below the 40-Week MA which has seen the commodity shed over 25% in its value.

While this sums up the interesting and important relationship that Crude shares with its 40-Week MA, the weekly charts have also developed a strong bullish divergence of the RSI against the price. It is evident from the chart that over the past many weeks, while the prices formed lower bottoms, the RSI did not which led to the emergence of a bullish divergence against the price. This lays the ground for a bullish case for Crude Oil over the immediate short to medium-term.

Crude has closed just above the 10-Week MA which is placed at $83.80. The most logical price target for Brent can be its 40-Week MA which currently stands at $98.55.

Zooming in further to the daily chart, the price has broken out from a symmetrical triangle that developed over the past few weeks. The classical price measurement implications of this pattern also hint at the levels of $96-$98 as the expected price levels that the commodity may test over the coming days.

For active short to medium-term traders of Brent, the level of $77 is critical; any slip below this will keep the commodity in a broad trading and consolidation range for some more time. However, for any catchers of the long-term trends, the 200-Month MA of $69.56 holds major support.

It’s a new year, so there’s no better time to take a step back and think about what will drive markets in the months ahead.

The Components of Inflation

At his November 30, 2022 speech, Federal Reserve Chair Jerome Powell described the 3 primary components of inflation – Core Goods, Housing Services, and Core Services less housing. Core goods drove the first wave of this inflationary cycle, as surging demand for tangible products during the pandemic came face-to-face with sagging production and supply chain disruptions. The next wave was led by a spike in the cost of housing.

Core goods inflation peaked in early 2022, and housing will likely peak around the middle of this year (see Figure 3 below). The Fed will look past what it sees as ‘transitory’ declines in core goods and housing inflation, and instead focus on the price of core services. These charts are from his presentation:

The Tightening Cycle

Powell and Co. claim they’ll do whatever it takes to cool inflation, even if it pushes the US economy into recession. It’ll take higher interest rates for longer, according to their models.

Wall Street doesn’t seem to believe them. While the median dot from the FOMC’s December Summary of Economic Projections implies a year-end 2023 rate of more than 5%, Fed Funds Futures are pricing in a rate not much higher than where we are now.

Labor Market Showing Signs of Weakness

The primary goal of the Fed’s interest rate hikes is to put a stop to excess inflation. To do that, they need to loosen an extremely tight labor market and dampen demand.

If you look at the unemployment rate alone, you won’t see much change, but beneath the surface, tightening monetary policy is having an effect. Weekly continuing jobless claims, while still near the lowest levels of the last 50 years, have jumped by 400,000 in the last 6 months. The 8 other times claims have risen this quickly, a recession has followed.

Credit Spreads

If the US economy is headed for recession, credit spreads aren’t showing it. A common feature of slowdowns in economic activity is increased default rates by both consumers and businesses. As a result, lending rates to those borrowers rise faster than the risk-free rate paid by the US government.

Credit spreads increased in the early part of 2022, but they’ve since stabilized. If negative GDP growth is ahead, this chart should give us advance warning.

Tech Stocks’ Big Top

Growth stocks were in control for more than a decade after the financial crisis. Being a ‘Value’ investor was synonymous with underperforming. That changed in September 2020, when Information Technology ran into the relative highs it set at the peak of the internet bubble.

Lots of people will argue that technical analysis is a farce. Price moves are random, and historical moves have no bearing on the future. Even more folks will balk at the importance of prices from more than 20 years ago – let alone the ratio of two price indexes.

Does the chart below look random? Do you really think it’s just coincidence that after a decade-long bull market, Tech just happened to peak at exactly the 2000 highs – the height of the biggest Tech bull market of our lifetimes?

In any case, Tech won’t be a secular outperformer again until it absorbs all this overhead supply. In fact, the latest weakness makes it more likely that the sector will continue to underperform in 2023.

Growth vs. Value

Much like the ratio of Tech to the S&P 500, growth stocks have underperformed their value counterparts for much of the last 2 years. There hasn’t been much reason to like the prospects of growth companies, especially in the face of rising interest rates around the world.

That seems to be the consensus opinion, though, and it often pays to play devil’s advocate. Here’s one reason to think 2023 could be different: the Russell 1000 Growth index is nearing a potential level of support relative to the Russell 1000 Value index. The ratio is currently at the 38.2% Fibonacci retracement from the entire 15-year rally.

Crypto

Cryptocurrencies had a tough year in 2022, and that weakness looks set to continue.

Bitcoin is stuck in an indisputable downtrend, having broken the summer lows in November following the FTX meltdown. Former support around 19000 is now overhead supply, and the next area to watch on the downside is 13000. A rally back above 20000 could quickly change the narrative.

Precious Metals

It’s been a while since precious metals were cool. Gold and silver both outperformed handily during the onset of the pandemic in early 2020, but then they lagged in spectacular fashion over most of the next 18 months.

2022 was a year of consolidation for the two metals relative to equity markets. 2023 might be the year they become leaders.

Investors have gladly hit the reset button after last year’s downhill ride on the S&P 500. What started with a champagne record high on the first trading day of 2022, fizzled out into a volatile bear market by June and nearly a 20% decline by year-end, marking the fourth worst year for the index since 1950.

Given the degree of last year’s decline and abnormal path of price action, including a single record high on the first trading day of the year, we analyzed correlation data to find years that most closely resemble 2022. More specifically, we calculated the daily return progression of the S&P 500 for every year going back to 1950 and then ran a correlation analysis comparing each year to 2022. The bar chart below provides a breakdown of each year’s correlation to 2022.

As you may notice in the chart above, very few years have a high correlation to 2022, which makes sense considering the average annual price return for the S&P 500 is 9.1% during this time frame. The year 1962 stands out with the highest correlation at 0.82, along with a few other years that have a relatively high correlation coefficient. The table below provides a deeper breakdown of these years, including how the market performed over the following year.

In order to provide historical context beyond correlation coefficients, we included some additional macro insights for each year above. A few key highlights:

• The highest correlation years to 2022 generally have higher annual returns over the following year.
• Of the 11 years observed above, seven included a recession, which spilled over into the following year during six of the seven periods.
• Of the 4 years without a recession, there were no recessions recorded over the following year.
• Annual price returns over the next year for all periods highlighted above averaged 11.7%, with only two years generating negative returns.

In terms of analogs to 2022, 1962 checks the box as the closest comparison based on the data above (highest correlation coefficient, higher trajectory of federal funds rate, and no recession occurring within the year). The chart below compares the price of the S&P 500 during 1962 and 2022. We also included the 1963 period for the S&P 500 along with its price return progression during the year to project a hypothetical path for the S&P 500 in 2023. Under this scenario, the S&P 500 would finish the year at 4,565 (+18.9% off the December 31 close).

Of course, this projection and correlation data comes with the major asterisk of correlation does not imply causation. And while history may not repeat or imply causation, it often rhymes, which would be welcomed by investors for 2023. Subsequent S&P 500 annual returns for years that closest correlate to 2022 tend to be above average and positive. History also suggests high correlation years that do not include a recession typically avoid one over the following year.

Adam Turnquist, CMT, VP Chief Technical Strategist, LPL Research

If bond markets aren’t stressing, why should we be?

They’re the largest markets in the world. That’s why we constantly monitor credit spreads for signs of structural weakness and elevated risk.

But, as of now, we’re not seeing the slightest hint of impending catastrophe.

Despite the doom-and-gloom headlines popping up in your inbox and financial media talking heads spinning an imminent recession…

Credit spreads around the world are sending a clear message: “Relax.”

Check out the overlay chart of option-adjusted high-yield credit spreads:

They’re all contracting to levels from last summer. Even the riskiest CCC-rated spread is reverting lower.

This is the exact opposite of what we would expect if the world was coming to an end and investors were running for the exits.

Instead, market participants are reaching for additional risk despite the tempting yields offered by risk-free Treasuries.

It could change, of course. But this isn’t bear market behavior.

“But Ian, it’s different this time. Risks exist in the sovereign debt market, not in corporate debt!”

OK, let’s look at European sovereign spreads.

Here are the spreads between 10-year French, Italian, Spanish, and Portuguese yields versus the German yield:

They’re all turning lower, too, with the Italian-German spread nearing its lows from last fall.

Again, this could change. But all we have is right now and all the data we can get our hands on preceding this moment.

Based on the evidence, it appears the sovereign debt crisis has been put on hold.

And when we consider the emerging markets, fuhgeddaboudit!

Even emerging-market high-yield credit spreads are turning lower! Check out the chart of the option-adjusted emerging-market high-yield credit spreads below:

We’re not talking about the summer or fall lows from last year. Emerging-market high-yield credit spreads are revisiting levels not seen since September 2021.

So, where’s the stress? I don’t see it.

When I take a step back, turn off the noise, and focus on these spreads, I don’t hear alarm bells going off.

Instead, I hear the bond market whisper, “Take it easy… follow trends, not headlines…”

I can even hear, “Buy high, sell higher… price pays…”

Perhaps it’s just me. Regardless, it’s clear the bond market is playing it cool as a cucumber.

That’s great for bonds and risk assets worldwide.

Stay tuned!