Did A “False Breakout” Just Happen? Here’s What The Charts Say…

As I’ve been saying over the past few months, we’re at an extremely important turning point in the market. Any day now, we could see a major trend change or breakout across the broader market — and, accordingly, things have been volatile.

So, as we have for the past few weeks, let’s break down what we’re seeing on the charts.

Because June is an important “seasonal” month, I want to start by looking at the seasonal trend. I calculate this indicator a year ahead of time. It’s a simple average of the trading activity on each specific trading day of the year. For mathematicians, it’s a calculation based on a periodogram.

This indicator recognizes that events happen at the same time of year, year after year. Earnings are released at similar times. Taxes are due at the same time, generally. And traders go on vacation around the same time of the year. (That’s widely recognized as one of the sources of weakness in the summer.)

The chart below shows the seasonal trend (blue) for the SPDR S&P 500 ETF (NYSE: SPY). The daily prices for this year are represented by the black bars, and they show that SPY bottomed only one day after the seasonal bottom in April. Last Friday’s peak came only one day after the seasonal peak in June.

As I noted last week, seasonals should not be the sole reason to take action in the market. But this is an indicator that’s worth watching this week as the market faces more news about inflation and an announcement from the Federal Reserve.

Keeping An Eye On Inflation

Last week’s report of the Consumer Price Index (CPI) showed inflation of about 5%. Much of the gain was due to increases in energy costs, used cars, and restaurant meals. Experts are telling us we should ignore these gains because gains in these sectors won’t be repeated.

However, I believe there’s one piece of the CPI that is going to be a problem — and that’s housing. Shelter accounts for 32.9% of the CPI. Home prices are rising, and so are rents.

The Fed knows about the gains in housing. Years ago, they came up with something they call “owner’s equivalent rent,” a number that they say accounts for what you’d pay to rent your own house. This formula smooths the changes in housing costs.

But the housing market has been making large gains. The S&P/Case-Shiller 20-City Composite Home Price Index is up 13% in the past year.

The gains in home prices will be reflected in the CPI in the coming months. This means inflation will stay near 5%, or even rise in the coming months.

This week, we got data on the Producer Price Index (PPI), which shows inflationary pressures in the supply chain. That was announced earlier this morning before the open, and those results reaffirm my belief that inflation will be here to stay, at least for a bit.

For May (the month just reported), PPI rose 0.8% month over month, which was higher than the 0.5% increase economists were predicting. What’s even more telling is that PPI has increased 6.6% over the past 12 months, which is the fastest annual increase on record.

Normally, all of that would spell I-N-F-L-A-T-I-O-N F-E-A-R-S. But investors don’t seem to be panicking. Even after the results were announced, the broader market was still hovering near its recent highs.

But that could all change on Wednesday afternoon, when the Federal Reserve concludes its most recent meeting and Fed Chair Jerome Powell gives us more details into the Fed’s vision of the economy. Traders will react to the Fed’s announcement at the conclusion of its meeting. And as we know, Chairman Powell has the ability to create a lot of volatility in these press conferences.

What My Indicators Are Telling Me

Looking solely at technicals, you can see that this week is important for stocks. Even the charts make it clear that something is in the air.

Just look at the next chart, where my Income Trader Volatility (ITV) indicator shows a potential breakout in SPY.

In the bottom panel of the chart, you can see that ITV (red line) is below its moving average (blue line). ITV is similar to VIX in that it rises as prices fall. Its current position is bullish.

We also have a small breakout of the trading range I’ve drawn in the upper panel. SPY closed above the upper dashed line that has defined the index’s months-long trading range. As I noted last week, when prices break out of a trading range, we usually see one of two things:

  1. The breakout is followed by a rapid price move in the direction of the breakout. This indicates a sharp up move is possible.

  2. The breakout is followed by a rapid reversals. This is known as a “false” breakout. Bullish traders buy the breakout. If prices reverse, they may panic and sell quickly.

We’re still watching to see which reaction traders will have to this small breakout.

Our last chart this week shows my Profit Amplifier Momentum (PAM), which is showing signs of weakness.

PAM, which is featured in the bottom panel of the chart above, is designed as a short-term indicator. The red bars are bearish, and the green bars are bullish. Currently, PAM is declining from a recent bullish peak that we saw a few weeks back, and this decline is a potential indicator of weakness.

Action To Take

My indicators are all pointing to the fact that last week’s new high could be a false breakout. We’ll know soon whether that is the case or not. I’ll also be watching the reaction to the PPI and the Fed press conference for confirmation.

In the meantime, as I’ve been saying for weeks, this is a time for traders to exercise caution. There are still plenty of viable trading opportunities in this market, but you will need to be selective. Also, be wary of committing too much capital to any one trade — or of making trades that tie up that capital for too long.

This is one of the reasons why my “insurance plan” trading approach works so well. It allows us to make short-term trades on stocks we already own (or want to own) without taking up too much of our capital. Even better, these trades pay us income instantly.

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