Trader’s Corner — Stock Fire Sale

In today’s Money Weekend…the Fed sparks a rally…bonds under pressure…get ready for bargains…and more…

It looks like it’s time for the markets to take a breather.

The Fed has raised rates by 25bps and indicated a potential rate rise at nearly every upcoming meeting this year, yet stocks rallied. Phew.

There was no mention of when they will start shrinking their massive balance sheet, which was probably the catalyst for the jump in stocks. But that’s coming soon.

I think it’s too early to rejoice and dive in headfirst buying every stock you can find. But we could be in for a relief rally for a while as the market considers what comes next.

The way I see things is that the weekly trend is down, and markets are rallying up into overhead resistance. The future depends on how markets react after they hit that resistance.

We have a nice line in the sand beneath the market.

I have been saying that a fall below 4,100 in the S&P 500 should set off a chain reaction to the downside.

That remains my view.

But that level may not be threatened for months, if ever. Or it could happen next week. All outcomes are still on the table at this juncture.

I will be interested in seeing how things play out over the next week as the knee-jerk reaction to buy after the rate rise runs out of steam.

Bonds under pressure

I have one beady eye on the US 10-year bond yield and corporate junk debt.

US bonds hit the POC

You can see in the chart above that the US 10-year bond yield has reached the 2.2% target level I have been discussing for months, which is the midpoint or point of control (POC) of the last decade’s trading.

The chart shows bond yields rather than bond prices. When the bars on the chart are going up that means yields are rising and bond prices are falling.

Now that my target of 2.2% has been reached, things can get interesting from here.

If 2.2% doesn’t end up being resistance and yields slice straight through that level and keep marching higher, there isn’t much resistance until the yield hits 2.5–2.8%.

So we may be in the early stages of a sharp sell-off in US bonds.

I’m not sure stocks will remain well bid if bonds continue to tank.

Junk debt has also seen strong selling pressure, but they found some buying support after the rate rise.

Junk bonds looking sick

The chart above shows the High Yield Corporate Bond ETF [NYSE:HYG] over the last decade. Over the last three months, the price has been dropping like a stone. If the recent low of US$80 is breached soon, it will probably have a knock-on effect to stocks.

Get ready for bargains

There are so many stocks on the ASX that have been completely smoked over the last year or so. I am starting to get quite excited about the prospect of another wave lower in stocks setting up some great buying opportunities in the small and microcap sector.

Now is the time to be doing your homework to figure out which stocks you want to own if the baby gets tossed out with the bathwater in a coming capitulation event.

People were falling over themselves trying to buy Zip Co [ASX:Z1P] at $12 last year and now you can get as many as you want at $1.60. There’s no sign that momentum is turning back up yet, so I can’t touch them based on my trading rules, but we must be getting close to a point where they could be worth a punt. Even if for a short-term bounce.

Market darling Nanosonics [ASX:NAN] has halved from $8 to under $4, and again I can’t buy it until I see momentum turn back up. But I am licking my lips, hoping we see another leg lower so I can scoop up some of those.

Medical device maker PolyNovo [ASX:PNV] rallied in a straight line for years to a high of $4 but was recently dumped to under $1. They will be on my shopping list soon.

PolyNovo plummets

A correction feeds on itself as current shareholders watch the value of their shares decline day after day. The decision to dump shares can end up being based on nothing other than the desire of the shareholder to stop the pain.

It is situations like this that my strategy was built for: a large retracement of a previous major wave that has shareholders panicking out of their positions without considering the underlying fundamentals of the business.

It’s not time to back up the truck just yet but investors should be sharpening their pencils getting ready for the bargains that will be on offer soon.

If you’d like some help sourcing stock trading ideas, then check out the seven stocks we have been buying at Australian Small-Cap Investigator.

Otherwise, continue below to check out my latest ‘Closing Bell’ video where I look at the current state of play for the major markets around the world.

Until next week,

Murray Dawes,
Editor, Money Weekend

PS: Watch the latest episode of my series ‘The Closing Bell’ on YouTube. Click here or the thumbnail below to view it.