This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe
Today's newsletter is by Jared Blikre, a reporter focused on the markets on Yahoo Finance. Follow him @SPYJared
Powell & Co. did it. Stocks surged and settled higher after a hotly-anticipated Federal Reserve decision and presser leaned more dovish than hawkish.
The big question for U.S. stock investors is how to play the market now. That question is ever-present, and ever-vexing. By many metrics, the stars are aligning for another rip-your-face-off rally. Whether it has legs or fizzles out like the other burgeoning bulls of 2022 remains to be seen. But first, the good news.
The best news for stocks might be that investors haven't been this bearish since the beginning of the 2009 bull market. Capitulation in sentiment can be a powerful contrary indicator. The latest readings from the AAII Investor Sentiment Survey are at levels showing capitulation by retail traders.
Searching for a bottom
Selling capitulation works in tandem with sentiment capitulation. Extremes in price and momentum often work to forge both market bottoms and tops.
The price action in the major indices last Friday and Monday were instructive — especially in the Nasdaq, which suffered its worst day since 2020. This was followed Monday by a probe to new lows for the year, which were promptly bought and followed by a furious rally into the close.
This is how the bottoming process begins.
"If they don't scare you out, they wear you out," says Alphatrends.net founder Brian Shannon. Whether they're terrified, despondent or just plain broke, once the bears are out of the game, it's time for the shorts to feel pain.
Most rallies off major lows begin as short-covering rallies — where traders who bet on stocks going down get a comeuppance. These can be quite frustrating for most investors, as the stuff that shoots up the most in the beginning tends to be what was just liquidated at firersale prices. (For options aficionados, a good gamma squeeze usually accompanies that first short covering squeeze as well.)
The back half of March was an excellent example, when the Nasdaq rallied 6% in two weeks. The beleaguered Ark Innovation Fund ETF (ARKK) was up 36% during this period. And one of the more liquid ETFs that tracks the Chinese tech space, KraneShares CSI China Internet ETF (KWEB), more than doubled in price.
Eventually, the rally petered out after the gas provided by wrong-way shorts dried up. At that point, any number of tailwinds can kick in to fuel the next major leg up. On the institutional side, it may be momentum-chasing futures traders levering up and buying the bull trend. Or FOMO-facing hedge funds forced to cannonball back in the pool, chasing those elusive returns.
The news cycle can kick in and catalyze the next leg up. For instance, it wouldn't take much for the Fed to tone down its hawkish rhetoric.
But the news can also work the other way, putting the kibosh on any nascent bulls. The fledgling March rally effectively died after Powell upped the hawkish ante on April 21. Market participants had not yet priced in the potential for the Fed moving 75 basis points at a clip. Powell just took that off the table.
Retreating bond vigilantes
The U.S. Treasury market may also be signaling a respite for risk markets. The 10-year Treasury bond yield just spiked above 3%, closing in on where market participants believe the Fed will eventually stop hiking short-term rates.
At these levels, there's a good chance that the relentless bond-market selling may reverse, or at least cool off — taking pressure off equities. Three percent is also a big, round psychological number that many traders were targeting as they shorted Treasury note and bond futures (one of the year's best trades).
Bottom line — the unprecedented selling in bonds, which has driven yields to multi-year highs — has obliterated liquidity and stoked painful, forced unwinds of leveraged trades as margin calls stack up.
Therefore, if the bond market calms, that headwind abates — and quite possibly becomes a tailwind, as liquidity returns and bruised portfolio managers chase returns again in what passes for Wall Street's virtuous cycle.
Of the recent events, Yves Lamoureux, president of Lamoureux&Co, wrote: "The 10-year yield went were we expected — 3%. The move was vertical, so it's done for now. From here, yields should move down and reflate the markets."
Navigating the next big move
Say we get another head-spinning rally — markets are still susceptible to another massive repricing of risk. Powell could get more hawkish. The Russian-Ukrainian war could escalate. Earnings revisions can suddenly turn quite negative (Credit Suisse notes they just inflected downward, which is bad for stocks 71% of the time). Corporate credit conditions — which have been worsening — could suddenly unravel.
The most bearish scenario at play is where the major indices crash to new material lows, making minced meat of battered stocks that recently looked "cheap." Hopefully, any short-term long punters take the pain of a loss quickly. (Thankfully, the risk to reward ratio for short-term trades is very favorable now, as most stocks are near 52-week lows.)
Whatever the move, the keys are risk management and patience. Don't risk too much, have an exit plan upon entry, and never force a trade (entry or exit). Overtrading is just as risky as pulling stops before they get hit.
If the trade doesn't work out, then wait for the next setup. Sit on your hands, if necessary. Sit on them until they hurt. That's the discipline.
In the end, "only price pays," says Shannon.
What to watch today
Economy
7:30 a.m. ET: Challenger Job Cuts, year-over-year, April (-30.1% in March)
8:30 a.m. ET: Non-farm Productivity, 1Q preliminary (-5.3% expected, 6.6% in 4Q)
8:30 a.m. ET: Unit Labor Costs, 1Q preliminary (10.0% expected, 0.9% in 4Q)
8:30 a.m. ET: Initial jobless claims, week ended April 30 (180,000 during prior week)
8:30 a.m. ET: Continuing claims, week ended April 23 (1.408 million during prior week)
Earnings
Pre-market
6:30 a.m. ET: SeaWorld Entertainment (SEAS) is expected to report adjusted losses of 15 cents per share on revenue of $262.46 million
6:55 a.m. ET: Apollo Global Management (APO) is expected to report adjusted earnings of $1.03 per share on revenue of $1.23 billion
7:00 a.m. ET: Zoetis (ZTS) is expected to report adjusted earnings of $1.22 per share on revenue of $1.98 billion
7:00 a.m. ET: Conacophillips (COP) is expected to report adjusted earnings of $3.18 per share on revenue of $17.89 billion
7:00 a.m. ET: Wayfair (W) is expected to report adjusted losses of $1.52 per share on revenue of $2.97 billion
7:00 a.m. ET: Penn National Gaming (PENN) is expected to report adjusted earnings of 44 cents per share on revenue of $1.52 billion
7:00 a.m. ET: Datadog (DDOG) is expected to report adjusted earnings of 11 cents per share on revenue of $337.33 million
7:00 a.m. ET: Crocs (CROX) is expected to report adjusted earnings of $1.55 per share on revenue of $621.75 million
7:00 a.m. ET: Shopify (SHOP) is expected to report adjusted earnings of 64 cents per share on revenue of $1.25 billion
7:30 a.m. ET: Dominion Energy (D) is expected to report adjusted earnings of $1.17 per share on revenue of $4.48 billion
8:00 a.m. ET: Royal Caribbean Cruises (RCL) is expected to report adjusted losses of $4.44 per share on revenue of $1.15 billion
8:00 a.m. ET: Kellogg's (K) is expected to report adjusted earnings of 93 cents per share on revenue of $3.58 billion
9:00 a.m. ET: Nikola (NKLA) is expected to report adjusted losses of 27 cents per share on revenue of $900,000
Post-market
4:00 p.m. ET: Luminar Technologies (LAZR) is expected to report adjusted losses of 13 cents per share on revenue of $8.05 million
4:05 p.m. ET: Virgin Galactic Holdings (SPCE) is expected to report adjusted losses of 32 cents per share on revenue of $280,333
4:05 p.m. ET: DoorDash (DASH) is expected to report adjusted losses of 11 cents per share on revenue of $1.38 billion
4:05 p.m. ET: Sweetgreen (SG) is expected to report adjusted losses of 44 cents per share on revenue of $101.86 million
4:05 p.m. ET: Opendoor Technologies (OPEN) is expected to report adjusted losses of 8 cents per share on revenue of $4.29 billion
4:05 p.m. ET: Zillow Group (ZG) is expected to report adjusted earnings of 25 cents per share on revenue of $3.39 billion
4:05 p.m. ET: FuboTV (FUBO) is expected to report adjusted losses of 60 cents per share on revenue of $243.00 million
4:05 p.m. ET: Lucid Group (LCID) is expected to report adjusted losses of 31 cents per share on revenue of $52.78 million
4:05 p.m. ET: Live Nation Entertainment (LYV) is expected to report adjusted losses of 78 cents per share on revenue of $1.9 billion
4:10 p.m. ET: Block Inc. (SQ) is expected to report adjusted earnings of 21 cents per share on revenue of $4.15 billion
4:15 p.m. ET: Corsair Gaming (CRSR) is expected to report adjusted earnings of 19 cents per share on revenue of $380.00 million
Yahoo Finance Highlights
—
Read the latest financial and business news from Yahoo Finance
Follow Yahoo Finance on Twitter, Instagram, YouTube, Facebook, Flipboard, and LinkedIn