Stocks: Even More Uncertainty Following Yesterday’s Rally

The stock market retraced most of last week’s decline yesterday as expectations of monetary policy easing quickly resurfaced following remarks from FOMC Members. Yesterday, I noted that “(…) currently, it appears to be just a correction of December’s advances”, and indeed, the prediction proved accurate.

On Monday, the index gained 1.41% after bouncing from the 4,700 level again. Last week, it sold off, reaching its lowest point on Friday since December 13 – the day that marked a pivotal shift in the Fed’s monetary policy.

In early December, the S&P 500 broke above the late July local high of around 4,607, resuming a rally from the medium-term local low of 4,103.78 on October 27. Last week, investors were taking profits off the table following the previous week’s rally. The index bounced off the 4,800 level and the resistance marked by January 4, 2022, all-time high of 4,818.62.

Investor sentiment remains bullish; Last Wednesday’s AAII Investor Sentiment Survey showed that 48.6% of individual investors remain bullish, surprisingly higher than the previous reading of 46.3%. The AAII sentiment is a contrary indicator in the sense that highly bullish readings may suggest excessive complacency and a lack of fear in the market. Conversely, bearish readings are favorable for market upturns.

This morning, stocks are expected to give back a part of yesterday’s gains, with the S&P 500 futures contract trading 0.6% lower. The market may undergo further consolidation ahead of the important Consumer Price Index release on Thursday.

As mentioned on December 21, “the likely scenario is a consolidation along 4,700-4800”, and, despite last week’s dip below 4,700, this prediction is remains accurate. How can we capitalize on such trading action? It’s better to shorten the timeframe of the trades and look for buying opportunities at support levels and selling at resistance levels.

The index went closer to its medium-term high yesterday, as we can see on the daily chart.

Stocks: Even More Uncertainty Following Yesterday’s Rally – Image 1

Nasdaq Gained Over 2%

Recently, the technology-focused was extending its uptrend, reaching a new all-time high of 16,969.17 on Thursday, December 28. On the previous Friday, I wrote, “While it continues to trade above its month-long uptrend line, there are, however, short-term overbought conditions that may lead to a downward correction at some point.”. Indeed, the market experienced a sharp sell-off last week.

Yesterday, it bounced sharply, but it still remains relatively weaker than the broad stock market gauge. The Nasdaq 100 approached last Tuesday’s daily gap down of 16,687-16,758, and it is likely to face some selling pressure here.

Stocks: Even More Uncertainty Following Yesterday’s Rally – Image 2

VIX – Back In a Range

The index, also known as the fear gauge, is derived from option prices. On Friday, it bounced down from the previous highs along 14.0-14.5 level, which was a positive signal. Yesterday, the VIX continued downwards, as stock prices were gaining. Historically, a dropping VIX indicates less fear in the market, and rising VIX accompanies stock market downturns.

Stocks: Even More Uncertainty Following Yesterday’s Rally – Image 3

Futures Contract Bounced From 4,800

Let’s take a look at the hourly chart of the contract. Recently it bounced from the 4,700 level, and today it is bouncing from the 4,800 level. The market is trading within a consolidation following its December rally. The resistance level is at 4,800-4,820, and support is at 4,760, among others.

Stocks: Even More Uncertainty Following Yesterday’s Rally – Image 4

Conclusion

Stocks are likely to open lower today, so the S&P 500 index will retrace some of its yesterday’s rally. It’s still hard to say whether the market will resume its medium-term uptrend or simply continue trading within a consolidation following November-December rally. Investors are waiting for the important Consumer Price Index release on Thursday, given the previous releases have led to increased market volatility.

On December 21, I mentioned that “in a short-term the market may see some more uncertainty and volatility”, and indeed, there is a lot of uncertainty following an early-December rally and the breakout of the S&P 500 above the 4,700 level. There is still a chance of extending the medium-term uptrend, as no confirmed negative signals have emerged.

For now, my short-term outlook remains neutral and I think that no positions are justified from the risk/reward point of view.

Here’s the breakdown:

• The S&P 500 is likely to retrace some of yesterday’s rally this morning.
• In the near term, stocks may extend a rebound, but it currently appears more like a consolidation than the start of a new uptrend.
• Short-term uncertainty and volatility may favor trading based on support and resistance levels.
• In my opinion, the short-term outlook is neutral.