Stock Market Correction Underway?

Summary

1. Stock market correction starting?
2. Volatility in gold market
3. Crypto market consolidates

Quick recap: Previous week

Last week, the Kvarn Pulse newsletter was written in a rather mixed mood. The stock market still appeared to be in an uptrend, but the momentum of the rally seemed to have broken, and the S&P 500 index had at least momentarily dipped. We also highlighted the strong rise in the price of gold and the robust performance of mining companies.

Has a correction begun?

Over the past week, the stock market's trajectory has continued to drift slightly downward. The S&P 500 index has fallen below its 10-day and 20-day moving averages. Furthermore, the 10-day average has crossed below the 20-day average, and both averages have turned downward.

At the moment, we define the 7,600 point level as the crucial dividing line. Located near this level are both the upper boundary of the May to July range and the 50-day moving average.

As long as the S&P 500 index remains above this level, it is still possible to maintain the interpretation of a mere "pullback" within an ongoing uptrend. Falling below 7,600 points would force a shift in interpretation toward an emerging downtrend.

If we had to make a guess at this stage, we would lean toward a break below this level.

A key factor in our subdued expectations for the S&P 500 index lies in the continued weakness of technology stocks. The ratio between the Nasdaq 100 index and the S&P 500 index (QQQ/SPY) made a brief visit above its 10-day and 20-day moving averages last week. In recent days, however, the ratio has once again returned below these downward-sloping averages, which are in turn below the downward-sloping 50-day moving average.

Until QQQ/SPY climbs back above at least its 10-day and 20-day moving averages, our expectations for index-level performance in the stock market will remain quite cautious.

Among the internal market ratios, the relationship between high beta stocks and low volatility stocks (the SPHB/SPLV ratio) had been showing promising signs for the longest time. This ratio, which often provides an indication of risk appetite in the stock market, has also dipped below its 10-day and 20-day moving averages in recent days.

In addition to the relative weakness of growth and technology stocks, rapidly deteriorating market breadth throws its own warning sign into the stock market outlook.

Just a few weeks ago, nearly 70 percent of S&P 500 constituent stocks were above their 50-day moving average. However, over the past two weeks, this proportion has fallen below all its moving averages, and notably below 50 percent as well.

The current situation in the stock market is therefore quite interesting. The S&P 500 index is currently only about two percent away from its all-time highs. However, reading the internal market indicators suggests that the market could be fully ready to turn into a clear correction. The key question for the coming week is how these somewhat conflicting signals will align into a more coherent picture.

A rising VIX index would make a particularly strong case for an elevated risk of a correction. Right now, the VIX is still at remarkably low levels and has just barely returned below its 200-hour moving average. However, this average is in an uptrend, which gives reason to keep a close eye on the situation.

On the bond market side, the MOVE index has climbed above its own 200-hour moving average. The MOVE and VIX indices typically do not move in opposite directions for long, so we will watch with interest to see if they find a shared direction in the coming days.

Gold price U-turn

The price of gold has seen a sharp reversal over the past week. In the first weeks of August, the price of gold rose very strongly. At its highest, the price of gold climbed close to its local May peak.

However, the speech given by Federal Reserve Chairman Kevin Warsh at the Jackson Hole symposium on Friday increased market expectations of potential rate hikes, pushing the price of gold into a sharp decline.

In our view, the drop seen so far still looks like a buyable dip. However, we are keeping a close eye on the $4,250 to $4,300 area, which is only a few percent away. A break below this level would begin to make it look like this is not just a dip, but that the upward momentum in gold has truly broken.

For now, our optimism is sustained by the fact that we have not yet seen gold mining company share prices begin to weaken significantly against the price of gold itself.

From the chart below, we can see that over the past year, the ratio between the gold miners ETF and the gold ETF (GDX/GLD) has turned into a clear decline simultaneously with, or even before, a drop in the price of gold. Until we see mining companies begin to weaken more clearly, we will treat the dip in gold prices seen so far as merely a promising buying opportunity.

It is also useful to remember that despite the sudden drop over the past week, the price of gold is still about ten percent higher than it was a month ago.

Crypto market: driven by tech or gold?

We have not seen major moves in the crypto market over the past week. Price changes for the largest tokens have mostly stayed within a few percent.

Right now, a natural question is whether the weakness we are seeing in the stock market could begin to spill over into cryptocurrency prices.

Historically, weakness in technology stocks in particular has been toxic for cryptocurrency prices. However, we note that in just the past few weeks, Bitcoin's price action has tracked gold more closely than technology stocks. It will be interesting to see which one Bitcoin tracks more closely going forward, especially if these asset classes start moving in opposite directions.

Regarding Bitcoin's price, we are watching the $75,000 area with great interest. A drop below this level would be a fairly strong indication that the upward move has faded into a mere bear market rally. We have not seen this happen yet, and until it does, we interpret the past week's sideways movement simply as a natural consolidation following a strong price rally.

Within the crypto market, altcoins have begun to weaken slightly against Bitcoin in recent days. This is a signal that warrants some caution, as it may indicate that investors are adopting a more defensive stance. For now, however, internal movements in the crypto market are quite small, and we avoid drawing strong conclusions from them.

Thematic ideas

For this week's thematic ideas, we will focus on reviewing the performance of last week's ideas.

Last week, we highlighted mining companies as thematic ideas, specifically those producing copper and uranium. The prices of ETFs in these investment themes were rallying strongly, much like gold and gold mining companies, and the "metal trade" looked ready to kick off in earnest.

Over the past week, however, the prices of these themes have taken a clear hit, much like gold.

The price of the Sprott Uranium Miners ETF is currently in an interesting position. If its decline stops at these levels, it looks like a very promising dip is forming, giving those who missed the sharp rally a "second chance" to get on board. On the other hand, if the decline does not stabilize at these levels, it would appear that the entire uranium theme's rally has broken, leaving the upward move as nothing more than a bear market rally.

Regarding copper miners, the situation looks more clearly like a buyable dip. The price of the Global X Copper Miners ETF has just touched its 200-hour moving average, and if the price truly turns upward from this area, it would be a highly promising sign.

In summary, although the performance of our thematic ETF ideas has been trending downward over the past week, we would not jump to hasty conclusions about abandoning them just yet. Next week will tell us much more, and we will see whether the "metal trade" should be shelved for now, or if we have merely witnessed a natural dip after a few weeks of exceptionally strong rallies.

We are living through quite interesting times in the financial markets. In our view, some dark clouds have gathered over the stock market. The next question is whether we will see these clouds condense into actual rain over the coming week. A natural follow-up question is, will cryptocurrency prices follow equity indices? And what about metals, are we currently in the best dip of the autumn, or is the metals rally already over? We may get answers to all these questions as early as next week.

Wherever the market goes, we will continue to monitor the situation and keep you up to date, so stay tuned!