This 'Rally" is coming to an end - here's why

Wow, what a week!

Last week we got to watch the market overcome one of the largest crises that it faced in the last year... the Debt Ceiling.

The politicians opted not to take this right up to the eleventh hour and do the market a favor by passing and signing legislation to raise the debt ceiling.  Instead, the deal got hammered out midway through last week which allowed the market to celebrate with a long-awaited rally.  I'm being a little sarcastic here, I hope you picked up on that.

Sure, last week's rally was one of the strongest since March of this year, but I'm guessing that investors are a little disappointed that they didn't wake up to the premarket trading another 2% higher, I mean is that it?  The rally is over already?

Yes... and here's why.

The market has been operating on a different style of discounting for the last year.

We've gotten so used to a crisis looming over the market's head. it's been so long that we've gotten to the point where we just assume that the crisis will be averted.  

Let's walk through a few.


The last earnings season was forecast to be one of the worst earnings seasons in decades due to the slowing economy.  Here are the stats for the season as it comes to a close:

  • 78% of the S&P 500 Companies beat their EPS expectations while 75% beat their revenue expectations.  That's an improvement in the last quarter.
  • On March 30, the expected earnings decline was -6.7%.  All ten sectors reported higher results than that forecast.
  • 66 of the S&P 500 companies issued negative guidance for the next quarter while 44% provided positive guidance.

I could go on and on, but you get the idea, those numbers weren't nearly as bad as expected.

Interest Rates

For more than a year now the market has been forced to deal with rising interest rates.  The alternative to that?  Out-of-control inflation is something that has already cut the consumer's confidence to the core.

The historically rapid ascent of the Fed's interest rates ranks among the most aggressive in recent history, but the market has been able to avert that crisis.

How?  Simple, by looking forward to the better times when the Fed will undoubtedly be lowering rates.  By some accounts, this could come as soon as the meeting in late July.  At least according to the CME FedWatch tool.

A look at the current Fed Funds Target by way of the futures market shows a healthy chance for another 25bps increase to rates in July though. That's the next "crisis" that we'll see, and the market will climb the Wall of Worry all over again.

But That Crisis Isn't Until July, How Does the Market Trade This Week? 

Well, we're heading into the week on a tepid note.

This morning we got reports on the economy in the form of April's Factory Orders and the ISM Non-Manufacturing Index.  Both were lower than expectations, telling you and I that there indeed are some weaknesses in this market that indicate a recession is not off the table.

The sector activity tells you the same.

The Russell 2000 Index ETF (IWM) had a great two days on Thursday and Friday as traders flocked into the market to buy some of the oversold sectors.  SPDR S&P Retail ETF (XRT), SPDR S&P Bank ETF (KBE) and Energy Select Sector SPDR Fund (XLE) also saw strong buying in the wake of the Debt Ceiling deal.  Let's talk about the XLE for a minute though.

Energy stocks had a great week last week as traders bid them higher ahead of the OPEC+ meeting this weekend.  Put simply, OPEC+ had already informed the market that they would be cutting production about two weeks ago.  This meant that it was time for the shorts to take their profits ahead of the meeting, which is exactly what happened.

As a result, the XLE shares rallied about 6% right to their recent highs of $81 ahead of a fast reversal during Monday's trading session.

My stance on the XLE remains unchanged.  Over the course of 2022, the energy trade including XLE, SPDR S&P Oil&Gas Equipment & Services ETF (XES), and SPDR S&P Oil & Gas Exploration & Production ETF (XOP) have all become crowded trades.  This means that there is still plenty of selling pressure remaining in the sector.

Keeping in mind that energy is also one of the sectors that are sensitive to recessionary risk.

The bottom line on the energy trade, a break below $76 on the XLE will signal continued weakness for the ETF as the "crowded trade" would continue to apply selling pressure on this ETF and its stocks.

What About the Russell 2000 Index?

I mentioned that the IWM had a couple of banner trading days as the market celebrated the passing of the debt ceiling legislation.  

This has been one of the worst-performing major indices year-to-date because of its sensitivity to the economy by way of the regional banks and retail sectors.

Both of those sectors are trading lower in the wake of the weak economic data this morning.  As of now, KRE is trying to trade back above its 50-day moving average (MA50).  That trendline is in a neutral position, meaning that the failure of the KRE to post a sound rally above it would suggest that a selling event is likely soon to come.

The post This 'Rally" is coming to an end - here's why appeared first on Penny Hawk.

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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