Markets

Fade: Market Hits Resistance as Breadth Waned

September 20, 2022

8 minute read

by Equity Research Team, Charles Schwab & Company Ltd.

Stocks' rally since mid-June has looked healthier from a breadth perspective, but low-quality leadership and deteriorating economic data have kept downside risks elevated.

After a strong rally that was healthier in breadth terms than the bear market rallies that preceded it, stocks bumped up against meaningful resistance last week amid overbought technical conditions. As shown below, the recent high for the S&P 500 was just shy of its 200-day moving average, which for now marked that resistance.

S&P 500 hits resistance

The S&P 500 closed at 4228 on Friday still below its falling 200-day moving average.

Source: Charles Schwab, Bloomberg, as of 8/19/2022.

Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly. Past performance is no guarantee of future results.

The S&P 500 lost 1.3% on Friday capping off a weekly loss of 1.2%, which ended the prior four-week stretch of gains. Shown below is the slight rolling over in the percentage of stocks among the three major indexes trading above their 50-day and 200-day moving averages.

Breadth rolling over?

The % of stocks above their 50-day moving average thru Friday for the S&P 500, NASDAQ, and Russell 2000 was 89%, 67%, and 76%, respectively. The % of stocks above their 200-day moving average thru Friday for the S&P 500, NASDAQ, and Russell 2000 was 45%, 33%, and 41%, respectively.

Source: Charles Schwab, Bloomberg, as of 8/19/2022.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

Source: Charles Schwab, Bloomberg, as of 8/19/2022.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

Breadth thrust … with a but

At the recent high, about 93% of stocks within the S&P 500 were trading above their 50-day moving averages—fitting the definition of a "breadth thrust." What makes it unique relative to others in history, however, is that the Federal Reserve is in an aggressive interest rate hiking campaign. Other than in February 2019 when the Fed was on hold, the nine other breadth surges off lows since 1975 all occurred during Fed easing campaigns (hat tip to our friends at Strategas for that stat). In addition, all 10 prior breadth surges (including 2019's) were accompanied by a positive 2y/10y yield spread. As most readers know, that yield spread is decidedly negative (inverted) today.

The rally that began in mid-June was directly related to the nearly 3.5% peak in the 10-year Treasury yield; with only two days separating that peak on June 14 with the S&P 500's low on June 16, shown below. Perhaps contributing to last week's weakness in stocks was the renewed upward move in bond yields—from a low that nearly reached 2.5% as August began, to about 3% today.

Bond yields driving stocks?

As of Friday, the S&P 500 closed at 4228 up from its June 16 low of 3667 and the 10-year Treasury yield was at 3.0% down from its June 14 peak of 3.5%.

Source: Charles Schwab, Bloomberg, as of 8/19/2022.

Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly. Past performance is no guarantee of future results.

As shown in our crowd-favorite index drawdowns table below, all three major indexes remain in negative territory year-to-date (YTD); though well up from their mid-June lows. We made some adjustments to the table for the purposes of this report; and have included the average member return from their YTD lows, as well as for each index's largest 10 members. In the final column, we also show the maximum "draw-up" (perhaps we have coined a new term?) for each index from their recent lows. Using the simple +20%/-20% definitions for bull and bear markets, given the >20% draw-ups for both the NASDAQ and Russell 2000, both re-entered bull markets (perhaps just in cyclical terms); while the S&P 500 did not hit that mark.

Drawdowns and "draw-ups"

The year-to-date return thru Friday for the S&P 500, NASDAQ, and Russell 2000 was -11%, -19%, and -13%, respectively.

Source: Charles Schwab, Bloomberg, as of 8/19/2022.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results. Some members excluded from year-to-date return columns given additions to indices were after January 2022.

What say you quilts?

At the sector level, leadership during the two months between the June 16 low and the recent high on August 16 was concentrated among the growthier Consumer Discretionary (+29%) and Technology (+23%) sectors, with the Energy sector the only one in the red (-1%) for that period. However, Utilities have been the best performer month-to-date (MTD), which suggests some underlying defensiveness has crept back into leadership characteristics. As shown in our monthly sector "quilt" below, sector swings continue to be notable; which is why we maintain our focus on factor-based investing.

Sector quilt highlights volatility

Over the past 12 months, Energy was the best performing sector with a gain of 76% while Communication Services was the worst with a loss of -28%.]

Source: Charles Schwab, Bloomberg. As of 8/19/2022.

Sector performance is represented by price returns of the following 11 GICS sector indices: Consumer Discretionary Sector, Consumer Staples Sector, Energy Sector, Financials Sector, Health Care Sector, Industrials Sector, Information Technology Sector, Materials Sector, Real Estate Sector, Communication Services Sector, and Utilities Sector. Returns of the broad market are represented by the S&P 500. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Returns assume reinvestment of dividends, interest, and capital gains. Past performance is no guarantee of future results.

We are doing a lot more work on factors—which are "characteristics," in lay terms—along with our colleagues within the Schwab Equity Ratings (SER) team, and we are looking forward to rolling out more of that research in the near future. In the meantime, we put together a monthly factor quilt, shown below, using Bloomberg's factors. Heading into June this year, five of the prior six months were led by value stocks; while even June had a more defensive bent with dividends on top. As the rally picked up steam however, higher volatility and trade activity bested the more fundamentally-driven factors of dividends and profitability in July and August-to-date.

Factor quilt highlights recent shifts

Over the past 12 months, Value was the best performing factor with a gain of 7% while Volatility was the worst with a loss of -6%.]

Source: Charles Schwab, Bloomberg. As of 8/19/2022.

The Dividends portfolio measures the most recently announced net dividend (annualized) divided by the current market price. The Growth portfolio captures the difference between high and low growers by using historical fundamental and forward-looking analyst data. The Leverage portfolio looks at firms' level of leverage using book and market leverage, along with debt to total assets. The Momentum portfolio separates stocks that have outperformed over the past year vs. those that have underperformed. The Profitability portfolio studies firms' profit margins using return on equity, return on assets, return on capital employed, and EBITDA margin. The Size portfolio distinguishes between small and large stocks using market capitalization, sales, and total assets. The Trade Activity portfolio is a turnover-based measure that looks at trading volume normalized by shares outstanding. The Value portfolio differentiates between "cheap" and "rich" stocks using valuation metrics such as earnings/price and book/price. The Variability portfolio gauges how consistent earnings, cash flows, and sales have been in recent years. The Volatility portfolio differentiates between more and less volatile stocks by looking at various aspects such as return volatility over the latest 252 trading days. Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly. Returns assume reinvestment of dividends, interest, and capital gains. Past performance is no guarantee of future results.

Given ongoing weakness in the economy and the more recent rolling over of forward earnings estimates, we continue to recommend that stock-picking oriented investors focus on quality-based factors, like higher profitability, dividends, lower volatility, healthy balance sheets and strong free cash flow.

Reversion to the meme

The aforementioned stronger breadth aside, a burgeoning characteristic of the rally was heightened speculative froth. Some of the largest gains during the rally were concentrated down the quality spectrum—namely among some of the meme stocks. Mimicking some moves seen in the latter part of 2020 and early months of 2021, speculative segments of the market went parabolic again recently. While it was GameStop that initially stole the headlines in early 2021, this time, Bed Bath & Beyond captured the zeitgeist.

Shown below, the "original" memes such as GameStop and AMC had double- and triple-digit percentage gains over the past month (the metric shown is each stock's performance from its rolling 40-day low). However, Bed Bath & Beyond broke through the ceiling in recent weeks, surging by more than 400% at one point.

The meme extreme

At one point from its rolling 40-day low, Bed Bath & Beyond surged by more than 400%, only to collapse shortly thereafter.

Source: Charles Schwab, Bloomberg, as of 8/19/2022.

Past performance is no guarantee of future results. Individual stocks shown for illustration purposes only.

We don't generally try to dissect the reasoning behind memes' explosive rallies; mostly because there typically isn't much (if any) fundamental analysis involved … generally, it's pure speculation. Such was the case with Bed Bath & Beyond (rated either D or F by SER throughout 2022 so far). Other than increased chatter about the stock within various chatrooms and social media sites, there was no concrete basis for it meteoric surge. That differs a bit from the original meme craze, which began as a rebellion against hedge funds that had aggressively bet against companies with weak (or no) fundamentals.

Tragically, for many retail traders—especially those who "got in" on the recent rally near the peak—prices have collapsed over the past few trading days for stocks like Bed Bath & Beyond. In fact, Friday's swoon was the stock's worst day in history, falling a whopping 41%. Compared to the early-2021 frenzy, the irony associated with the stock's decline this time is that it was a billionaire investor's fund that came out on top—pocketing a hefty gain from a sale near the peak, which triggered the rout in the stock. On top of that, capping off the trading week was an announcement that the company's suppliers are restricting or halting shipments as the retailer has fallen behind on payments.

As is always the case, we never point out individual stocks for recommendation (either buy or sell) purposes. The flash rally and crash of stocks like many of the memes should serve as an important reminder for investors: Neither "get in" nor "get out"—and/or "get rich quick" schemes—are investing strategies. They simply represent gambling on moments in time—the antithesis of investing, which should be a disciplined process over time. That's a good place to end.

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