Chart Advisor: Micro Caps Melt Down – Stocks experience a broad-based selloff for the fourth straight day.

By J.C. Parets & All Star Charts

Monday, 19th December, 2022

1/ Micro Caps Melt Down

2/ Bear Market Base

3/ Breakevens Break Down

4/ Sugar Futures Look Sweet

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1/ Micro Caps Melt Down

While mid caps are outperforming large caps, small and micro caps have severely underperformed since the beginning of November. When we look for information about when and where the major averages might find support, we can use the iShares Micro-Cap ETF (IWC) for an early indication, as the index could be the first to break down due to its relative weakness.

This daily line chart of IWC shows price heading back toward the same level of support from June and September. Notice how this key polarity zone also coincides with the pre-pandemic crash peak in early 2020, just north of 100.

We’re watching micro caps closely to see if this former resistance level will once again become support. However, as this is now the third test of this level, a violation to the downside should not come as any surprise.

2/ Bear Market Base

We’ve been writing about the relative strength from defensive stocks in the past few weeks. Low-volatility stocks are a great example of this theme.

When they are rallying on a relative basis, the broader market tends to be under pressure. As you can see from the chart below, this has been the case since last year.

Today, the relative trend of low volatility stocks versus the S&P 500 (SPLV/SPY) closed at its highest level in roughly two and a half years as the ratio looks poised to resolve higher from a rounding bottom pattern.

Seeing this ratio complete a bearish-to-bullish reversal suggests risk assets could remain under pressure, as an increasingly risk-off tone grips markets.

3/ Breakevens Break Down

Instead of guessing the future direction of inflation, let’s break down where it’s been and where it is today. The 10-year breakeven inflation rate peaked in April and has been heading lower since, closing below its prior-cycle highs last week, which coincide with the 2018 peak.

Whether the Fed has fully defeated inflation remains unseen, but the 10-year breakevens are printing their lowest level in nearly two years.

This chart looks eerily similar to crude oil and gasoline futures, as both pro-cyclical commodities have undercut their prior-cycle highs. As long as inflation expectations continue to trend lower, inflationary assets such as commodities could do the same.

Selling pressure continues to pick up as risk assets across the board turn lower. The markets continue to present challenging conditions that demand caution.

4/ Sugar Futures Look Sweet

While breakevens roll over with energy contracts such as crude and gasoline, other commodities could be ready for potential rallies heading into the new year. Many of these contracts belong to more defensive areas in the agricultural space, such as softs or grains.

For example, sugar futures are trading within a tight range as momentum recently hit overbought conditions.

Momentum often leads price, providing valuable insight into whether bulls or bears hold court. This time could be no different, but we would like to see another bullish momentum reading on a decisive upside resolution as confirmation.

The bullish patterns in agricultural commodity futures remind us that inflation remains elevated, and less economically-sensitive assets could provide investors with the best long opportunities over the coming weeks and months.

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Originally posted 19th December 2022