The Bounce
The S&P 500 Index (SP500) is currently about 2.5% below the all-time high point reached on July 16th. The current “dip” started with the test of the 20-day moving average first, and after the 20dma breakdown, the selloff stopped at the next support, the 50dma. The 50dma support was breached on two occasions, with the most recent intraday drop a day before the Fed’s meeting on July 30th.
On July 31, the day of the Fed’s July meeting, the S&P 500 rallied hard straight into the 20dma resistance. As of now, the S&P 500 is still in a downtrend, as long as it remains below the 20dma resistance, as the chart below shows.
However, the bounce itself feels like it was a bear market rally, even though the S&P 500 is not officially in the bear market. The bounce was highly technical in nature and the leadership was questionable, which gives more credence to the possibility that the July 16th top could in-fact be a turning point.
Specifically, the bounce has been led by Nvidia (NVDA), which was up by almost 13%. As I previously said, the S&P 500 is not in a bear market yet, however, Nvidia is in the bear market.
Nvidia was down by around 25% from the top, and reached the key support of 100dma the day before the bounce. The sharp bounce from the key support is the classic bear market rally. Nvidia is still in a downtrend, facing the resistance at the mini-death-cross forming, where the 20dma is crossing the 50dma.
Note, Nvidia is the third-largest component of the S&P 500 with 6% weight in the index. Thus, Nvidia’s bounce pushed the S&P 500 higher as well. More importantly, the entire semiconductor industry bounced sharply, with the VanEck Semiconductor ETF (SMH) rising almost 8%.
But, SMH is also in a bear market, down by 20% from the top before the bounce. Thus, the bounce feels like a bear market rally. Note, the day before the rally SMH breached the 100dma support, which possibly caused more short selling. Thus, the bounce is a possible short-covering rally.
Thus, given that the semiconductors and Nvidia are in the bear market, the sharp bounce could have been just a bear market rally. Bear market rallies are usually sharp, starting from the key support, as shorts take profits, and longs anticipate the bounce.
Given the importance of Nvidia in the S&P 500, and the semiconductors in Nasdaq 100 (QQQ), the broad indices bounced as well. What happens next? It depends on the fundamentals.
However, the technical bounce can continue, and if the key resistance for S&P 500 is broken, the new highs are possible. Interactive Brokers reported that retail investors were heavily buying into the selloff, particularly Nvidia, just before the bounce. Thus, the retail investor is buying the dip.
The fundamentals
First, it’s important to understand what caused the bear market selloff in Nvidia and the semiconductors. It appears that the current selloff could be the Gen AI bubble burst.
In fact, it appears that the Gen AI hype is fading. Just before the peak, Goldman Sachs (GS) released the report titled: Gen AI — Too much spend, too little benefit and questioned the rate of return on Gen AI CapEx:
Tech giants and beyond are set to spend over $1tn on AI capex in coming years, with so far little to show for it. So, will this large spend ever pay off?
The Gen AI hype and the CapEx expectations inflated the bubble, with Nvidia’s PS ratio still at 32. Now, it seems like there is realization that the Gen AI adoption is not as widespread as expected, and the Gen AI monetizing will not happen over the near term. Alphabet (GOOG) (GOOGL) and Microsoft (MSFT) both failed to address the Gen AI CapEx ROR question.
Obviously, if there is a sudden change in the Gen AI CapEx profitability perception, the further upside in Gen AI related stocks could be justified, but this is very unlikely.
Yes, the data is still showing a solid growth, and the US economy is not in a recession. But, the unemployment rate is rising, and we are near the point where the Sahm Recession Rule is triggered — meaning when the unemployment rate rises by 0.5% from the low point, based on the 3-month averages, the recession usually follows. The Sahm Rule could be triggered this month.
But, there is also plenty of evidence that the economy is sharply slowing from the corporate earnings. For example, Starbucks (SBUX) continues to struggle with the global comparable sales down by 3%. One of the large retailers, Conn’s (CONN), just filed under Chapter 11, and it plans to close all 533 stores.
What did the Fed say?
The bounce happened on the day when the Fed was supposed to signal the first interest cut in September.
The Fed did not signal the cut in September, at least not in the post-meeting official statement. The policy guide statement did not change:
The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.
The post-meeting press conference was more dovish, but the Fed Chair Powell has been dovish on all recent press-conferences, yet, the Federal Funds rate remains unchanged.
In my opinion, the Fed is waiting for more evidence that the labor market is slowing, or more evidence of a recession, before cutting interest rates. At this point, the Fed sees the labor market weakness as normalization and not a sign of a recession.
Implications
The S&P 500 has staged a bounce into resistance, from the key near term support. Given the fundamentals, as discussed above, the bounce is technical in nature, and given that it’s led by components already in the bear market, it feels like a bear market rally.
With that said, the rally can continue based on sentiment, especially if the key resistance levels are broken. The retail investor is buying the dip.
However, the fundamentals are deteriorating, both the economic fundamentals and the industry-specific Gen AI fundamentals. The prudent strategy for most investors is to reduce the exposure to the S&P 500.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
Read the full article here