Trading Desk: Pick Your Support Spots While You Can

It’s a little gruesome out there. The job market that felt too hot last week startled investors yesterday by flashing too cold for comfort . . . but today’s inflation numbers shut the door on any relief in the near future.

The S&P 500 is once again testing the 20% bear market zone. Even the blue-chip Dow has fallen a full 15% from its peak across the last five months. As for the NASDAQ, I think Big Tech will be dead money for months to come.

Granted, earnings season is coming up and might give the bulls a little fundamental fuel. But realistically, reading between the lines makes me suspect that a lot of investors have already given up. They expect the Fed to raise interest rates past the economy’s pain point . . . without managing to get prices under control.

I remain guardedly optimistic on both the inflation front and the growth front. While prices are unlikely to come down from here, the Fed’s program seems to be suctioning a lot of excess cash out of the economy. central bankers remain highly recession averse.

However, with consumer sentiment tracking at its lowest since the mid-1970s, that hope is not exactly a majority position right now, even on Wall Street. Either way, we just won’t know for weeks to come.

So say the worst-case scenario plays out and the Fed makes the situation worse. Bonds are no comfort. Cash is getting chewed up in this inflationary environment. Which stocks look strongest as a place to park your cash until things get better?

Odds Against The Broad Market Now

None of the big market benchmarks looks worth buying and holding for near-term gratification right now. They just don’t have technical support on their side . . . and from a statistical perspective, that means they’re less likely to go up than down.

When you’re playing the probabilities, that’s not the kind of table you want to stay at. You’re going to want to take your chips and go elsewhere.

Yesterday that wasn’t the case. Even after a day of selling, the NASDAQ, S&P 500 and Dow industrials all had short-term support to hold them up. This morning, that tentative floor cracked.

Now the NASDAQ needs to hold its recent low or it becomes highly vulnerable to a retest of the mid-2020 low . . . roughly another 10% drop from here.

That’s only a notional bottom, the next chance that end of the market would have to arrest its fall. If the mood gets really bad, the real bottom could easily retest the 2020 COVID low, when people thought the world was completely unraveling.

And meanwhile, the easy upside potential just doesn’t look all that appetizing. The NASDAQ now has resistance to contend with if it climbs more than 4% . . . while that doesn’t rule out a bigger move if Big Tech earnings are good, a rebound beyond 10% from here looks pretty unlikely at this point.

The S&P 500 has similar dynamics weighing against it, despite its relatively low weighting to the tech stocks that are now such a drag on the NASDAQ. If anything, the risk-return profile looks a little worse. The broad market can theoretically recover near-term support and bounce up to 7% before hitting real resistance, which is nice.

However, if it falls another 4%, there’s nothing between the S&P 500 and the absolute COVID bottom. That’s not where we want to be. I don’t think the market deserves to be trading anywhere near that level of desperation, but we can’t control the amount of fear other traders are feeling.

Paradoxically, the Dow is in the worst statistical position here. Unless it recovers support in the next few days, the floor is a long, long way down . . . and because these blue-chip stocks tend to be mature and “defensive,” it’s going to take heavy lifting to squeeze even 4-9% in upside before fairly solid resistance intervenes.

A lot depends on reaction to next week’s Fed policy statement and then the big bank earnings next month. For now, the odds just don’t argue in favor of holding on when you could either win 6% or lose 20% with roughly equal likelihood.

How About The Sectors?

The reason the broad benchmarks are so gloomy revolves around the breadth of the last few days of selling. There aren’t a lot of bright spots.

The ultra-defensive utilities are in decent shape, with firm long-term support about 2% down from here. If the fear factors boil over next week, we could see investors crowd into these stocks for safety . . . and you’ll want to be here early in that scenario.

Admittedly, the sector as a whole only pays 2.8% a year in dividends at this price, but it’s fallen so far recently that a 7-10% rally isn’t off the table here in the short term. Balance that against the firm floor and this is where nervous money can hide.

If you’re more reward-oriented, energy is still the only target-rich sector right now. Even though these stocks have collectively doubled from pre-COVID highs, they can theoretically run as far as the oil market remains hot. With Russian supply off the market, that can be a very long time.

Can oil crash? Of course. But energy stocks have multiple levels of support below them now . . . each of which needs to break down before the sector can drop below that point. Rock bottom might be a full 25% down from here but I’d be a little shocked if Big Oil does a lot more than correct on global recession fears.

Consumer stocks are more of a mixed bag. The mood around retail has gotten too bad to really recover until at least one more earnings cycle rolls around, while “new consumer” names like Amazon (AMZN) and Tesla (TSLA) are exposed to truly apocalyptic declines if they fail to hold their recent lows.

Admittedly, TSLA has found support in the past year around $540, but that’s probably not comforting if you bought in above $1200. And if $540 cracks, the chart starts to look like a free fall situation.

Likewise, technology is in a precarious place. If the sector can’t recover today’s losses fast, the next step down opens up the prospect of another 20% slide . . . or even a 50% reversion to the COVID bottom. Again, nobody wants to contemplate that. Unless you’re extremely patient and have nerves of steel, pick your positions carefully or just steer clear.

The banks look equally vulnerable. Maybe they can rebound 7% on relief if the Fed is comforting next week . . . but if not, there’s no real safety net between the financials and a 30% drop.

I don’t think we go that low, but support levels are all about probabilities. The financials might drop another 30% before the selling strains statistical reality to the breaking point. On the other hand, they could easily arrest their fall well before that stage . . . or even go up from here.

Nonetheless, the chance to win 7% or lose 30% does not exactly thrill me. Keep the banks off your plate for now. If you want additional defense, the industrials and materials producers are a coin flip . . . neither good nor especially bad.

Healthcare has a lot of support, so serious losses are unlikely here. If you have a little more nerve, real estate feels close to a bottom and could rebound as much as 10-12% on any prolonged flight to safety, while paying dividends along the way.

So that’s the sweet spots and the pain points as I see them. Whatever happens next week, never forget: you don’t have to invest in the market as a whole. Sometimes that’s actually a bad idea. Pick your positions and you can get a smoother ride.