Ignore the Debt Ceiling at Your Own Peril

We're kicking off the week with a familiar feeling - being a little nervous while simultaneously saying to ourselves, "There's no way."

I Don't Want To, But We Need To Talk Debt Ceiling

There's no way they won't come to a solution to the debt ceiling.

I said it to you a few times last week, the media says it, hell, the President and the Speaker of the House have said it; so why does it feel like this time it could be different?

Over the weekend, the two parties most familiar with the situation issued statements making it clear they were further from a deal than had been anticipated. This morning's futures appear to indicate the story isn't a concern yet, and there's a reason why.

At this juncture, it feels like it would be political suicide to allow the federal government to go into default in just a week or so, and the markets believe that the "players" understand that. They probably do, but there was another time they understood this same problem...

Note the last sentence of that opening paragraph from August 5, 2011.

"... in the wake of a political battle that took the country to the brink of default."

Sounds eerily like the situation that we are watching unfold right now.

For what it's worth, here's the corresponding chart of the S&P 500 after the S&P downgrade...

A few weeks later, the FOMC had an interest-rate meeting at which they decided - under Ben Bernanke - to keep the target rate in a range between 0 and 0.25 percent. That's right, money was free at this point, as the economy was still being driven by the Fed's Punch-Bowl Policies.

Today, an additional layer of difficulty is present, as the current target rate is between 5 and 5.25 percent. Not only do the rating companies like S&P have to worry about the "political battle" when assigning their ratings on the U.S. debt, they also need to worry about the skyrocketing costs associated with servicing the debt. You get the idea.

Here's What It Means For Us

I'm still operating under the expectation that the debt-ceiling situation will indeed be resolved but think the resolution comes with a certain risk afterwards.

The market is heading into that seasonally-quiet period of June that often leads to a little "drift" lower in stock prices as we head into the next earnings season, which will kick off in mid-July. For now, I see this as the risk for the market, not the debt ceiling.

That said, the breadth of the market is telling us we're still not trading on solid technical ground. Let's talk about that for a moment.

Market Breadth Remains Bad, But There Are Some Bullish Opportunities

"We're going to see a 'slingshot' trade come into play soon."

Those were my thoughts as I went through the charts of the S&P 500 and Nasdaq 100 this weekend.

The Nasdaq 100 is trading 26% higher for the year. Offhand, I'm not sure when the last time the Invesco QQQ Trust Series 1 (QQQ) posted returns like that by June, but I'll go out on a limb and say it doesn't happen often.

Despite the stunning strength in the QQQ, only about 60% of the stocks that make up the index are trading above their 50-day moving averages (MA50). This number is way off from where it should be if we were in a bull market.

But there's an opportunity for that to change...

For months, we've heard about how QQQ shares have been driven by the likes of Apple Inc (AAPL), Microsoft Corp (MSFT), Alphabet Inc. (GOOGL), and Meta Platforms, Inc (META). While this is true and makes for a harder rationale to buy the index, there are some short-term trades in the companies that are getting ready to potentially slingshot higher.

Last week, the percentage of companies above their MA50 in the Nasdaq 100 started to break toward higher readings, which means we could see a last push into the end of the month for the QQQ.

Looking closer, there's a short list of companies getting ready to break above their respective MA50s, putting them in a position to slingshot higher as they start to catch up with the rest of the sector. Here they are:

Here Come the Biotechs Again

Two weeks ago, we talked about the potential for the SPDR S&P Biotech ETF (XBI) to see some selling pressure as the result of profit-taking kicking in.

XBI shares had rallied 20% from their March bottom on good volume and a number of merger and acquisition announcements. Last week, the XBI dropped 5% to its 20-day moving average (MA20) before reversing higher. That quick 5% drop, with the successful test of the "Trader's Trendline," is a textbook profit-taking move.

Monday morning, the shares took out their 10-day moving average and are leading higher. We continue to see strong volume on these moves, indicating participation is being driven by confident traders.

Given this healthy pullback to strong technical support, the XBI should remain on your short-term bullish list with a target of $92.50.

On the bearish side, the Energy Select Sector SPDR Fund (XLE) is at a technical crossroad. Last week's moves in the United States Oil ETF (USO) failed to break above a technically fortified resistance level at $65. Early trading on Monday shows some selling that may breach $63 and then target $60.

While energy companies have maintained the attention of large institutions and funds, it looks like the smaller traders and retail investors have been more attracted to the gains and fast-moving trades in the growing A.I. area of the market. This has resulted in a drawdown in trading activity in the energy companies.

As of now, average weekly trading volume on XLE shares is half of its peak in 2022. Just one sign that the sector has cooled from a sentiment perspective.

As I indicated at the beginning of the year, the energy trade was one of the most crowded on Wall Street, as it was almost the only trade that worked in 2022. While great for investors in 2022, it also meant the sector faced some risk of the crowded trade deflating as investors started to move from the sector.

To some degree, the migration from the energy sector appears to have started and should be considered a headwind for prices among the energy stocks.

I'll break the sector down in detail on Wednesday's Deep Dive.

This Week's Watchist:

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About the Author

Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.

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