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A stock-market relief rally appeared to be shaping up to start the week, but the potential reward from chasing a bounce from here remains limited, according to one Wall Street technician.
The August downtrend in stocks extended through a third consecutive week as of Friday’s close after Federal Reserve chair Jerome Powell said at the Jackson Hole economic symposium that it is still unclear if interest rates will need to rise further as policy makers remain unsure of whether more rate hikes are needed, said Tyler Richey, co-editor at Sevens Report Research.
The spike in the stock-market volatility was evident in the Relative Strength Index (RSI) indicator, which measures the speed and magnitude of an index or a stock’s recent price changes to evaluate overvalued or undervalued conditions. Traditionally, the RSI is considered overbought when above 70 and oversold when below 30.
The chart below shows that the RSI indicator reached overbought territory midweek before falling into oversold territory on Thursday.
Friday’s “whipsaw drop to new lows for the week” on the S&P 500 futures
ES00,
was not confirmed by new lows in the RSI indicator, which means the market is setting up for a potential relief rally to start the new week with resistance at a range of 4,465 to 4,515 in focus, Richey said in a Monday note.
“Whether or not such a relief rally is able to break beyond the August downtrend line will be critical for the near term trend in stocks as a failure would leave the path of least resistance lower,” he wrote.
SOURCE: SEVENS REPORT RESEARCH
U.S. stocks on Monday continued a breather from the August pullback, with the large-cap S&P 500 index posting its first back-to-back daily gain in a month.
The S&P 500
SPX
rose 27 points, or 0.6%, to end at 4,433 on Monday, while the Dow Jones Industrial Average
DJIA
advanced 213 points, at 34,559, and the Nasdaq Composite
COMP
was up 0.8%, at 13,705. For the month, the S&P 500 has lost 3.4%, on course for its biggest monthly loss of 2023, while the Dow industrials were down 2.8% and the Nasdaq Composite has dropped 4.5% month-to-date, according to FactSet data.
These pullbacks are seen as a contrast to the artificial intelligence-driven rally earlier this year when the Nasdaq had its best first-half performance since 1983.
The set up for a relief rally is in place for the Nasdaq Composite, with a run at 14,000 possible in the very near term, said Richey. However, that upside target would ultimately begin to act as price resistance in the event it is reached in the early fall, he said.
The chart below shows the technical indicators for the Nasdaq Composite remain “very mixed but slightly in favor of the bears for now,” said Richey. The RSI is the only indicator favoring the bulls as it has offered a degree of confirmation for the recent stabilization in the Nasdaq. However, the blue line in the middle sub-chart, which shows the Nasdaq’s relative strength to the S&P 500, continued to drift lower, supporting the bear case for the months ahead, according to Sevens Report Research.
SOURCE: SEVENS REPORT RESEARCH
See: Investors parked heavy in cash may be making a ‘mistake’, Nuveen says
Moreover, on Wednesday, the yield on the 10-year
BX:TMUBMUSD10Y
and the 30-year Treasury
BX:TMUBMUSD30Y
finished at their lowest levels in more than a week, while the yield on the 2-year Treasury
BX:TMUBMUSD02Y
settled at its highest since March 8, according to Dow Jones Market Data. The moves in the bond market is referred to as a “negative yield-curve twist,” which sees the short duration yields rising while longer duration yields declining meaningfully, said Richey.
“The moves in Treasuries last week suggest economic growth is expected to deteriorate further in the midst of a stubbornly hawkish Fed,” said Richey. “While a deepening inversion leaves the door open to a relief rally in the near term, the deep inversion leaves the risks of something breaking in the financial system historically elevated.”
On Monday, the yield on the 2-year Treasury declined less than 1 basis point to 5.048% from 5.054% on Friday, while the yield on the 10-year was down 2.9 basis points, at 4.210%, according to FactSet data.
“Bottom line, the risk of a near-term relief rally in stocks is elevated as we start the week, but the potential reward of chasing such a move to the upside from here is limited when all other market trends are considered, especially the ‘negative yield-curve twist’ we saw last week,” he added.
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