The State Of The Market In 2 Charts

If you’ve been following me for the past while, you know I love charts. Some may even think I use too many charts.

Well, today, I am here to say that the current state of the stock market can be summarized with just two charts.

The first is the daily chart for Invesco QQQ Trust (NASDAQ: QQQ) with its 200-day moving average (MA).

As prices peaked in February, QQQ was about 20% above its 200-day MA. This is unusually high. With QQQ at such an extreme valuation, analysts expected a pullback.

The 200-day MA shows the average trend in the stock market. In the long run, we tend to see prices move above and below the MA. There is often a degree of symmetry in those moves. For example, at the low in March, QQQ was about 20% below the MA.

One reason for the symmetry is the fact that the distance from the MA shows the degree of emotion in the market. Extremes of exuberance are shown as large rallies above the MA. They are often followed by extremes of pessimism, which lead to large declines below the MA.

By the beginning of September, QQQ had rallied back to an even further extreme — more than 33% above its 200-day MA. That indicates the current pullback carries significant downside risk. The MA is warning us that the decline in the market could be deep.

The Outlook

As of now, QQQ is still 19% above its 200-day MA. That should give you some indication of the potential risk still left in the market.

One reason QQQ’s price has moved so far above the MA is the influence of the Federal Reserve. As I noted last week, the 13-week rate of change (ROC) of M2, a broad measure of money supply, can be used to quantify Fed policy.

The chart below shows the S&P 500 (black line) in the top panel. The 13-week ROC (blue line) is in the bottom panel. The dashed line at the bottom of the chart shows ROC at 2%. The green bars in the upper part of the chart highlight periods when ROC exceeded 2%.

Source: Optuma

Last week, for the first time since March, the ROC of M2 dropped below 2%. This week, it moved back up slightly to 1.5%, the first time the indicator showed an increase in 10 weeks.

For now, we don’t know if this increase was a small adjustment to the money supply or a reversal in Fed policy. We might know more later this week, after Chairman Jerome Powell speaks at his scheduled press conference on Wednesday.

Action To Take

Here’s what we do know — the Fed is not expected to change interest rates at this meeting, or at any time for at least the next six months. That makes the statement issued after each meeting and Powell’s comments important to market watchers. It’s likely stock market averages will make a big move on Wednesday depending on those comments. The direction of that move will help us understand the short-term trend.

While waiting for confirmation of the Fed’s policy, I will be looking to add put options to our portfolios since the path of least resistance in the stock market appears to be down. At least for now.

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