Chart Advisor: Evidence of a Tactical Bottom

By J.C. Parets & All Star Charts

Thursday, 23rd February, 2023

1/ A Big Candle for Small Stocks

2/ Bottoms Are a Process

3/ Participation Expands in Europe

4/ Will Crypto Catch Down?

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1/ A Big Candle for Small Stocks

Stocks have been trading in wide intraday ranges and experiencing downside volatility all week long. When we look at the major averages, there is growing evidence of a tradeable low on the most tactical of timeframes.

Here is a daily candlestick chart of the small-cap Russell 2000 Index (IWM) going back to the fall of last year:

Examining the most recent price action, we had a doji candlestick yesterday, followed by a hammer today. A doji signals indecision, as buyers and sellers wrestle for control of the short-term trend. Considering the current level represents the pivot highs from last year, as well as the 38.2% Fibonacci retracement of the most recent advance, indecision could be expected at this level.

However, seeing as yesterday’s doji was followed by a test of the lows this morning and a hammer candlestick today, the bulls may be winning. If we see upside follow-through tomorrow, it could confirm today’s hammer and indicate that a new price advance is underway. We’re seeing similar price action in the other major stock market averages.

2/ Bottoms Are a Process

Although major U.S. averages remain stuck below overhead supply, we’ve seen market internals improve since the beginning of the year.

The chart below shows the S&P 500 putting in a series of higher highs and higher lows, along with more new highs than lows at the individual stock level in the lower pane.

Although the improvement compared to last year is evident, the S&P 500 is still in a base-building process. This could foreshadow a choppy market over the coming weeks and months. While market internals have been supportive of the rally since late last year, more work may need to be done before any significant upward momentum takes place.

3/ Participation Expands in Europe

We’ve written previously about the recent outperformance from European equities, as evidence suggests the relative trends have shifted in favor of ex-U.S. stocks.

The chart below shows the MSCI Ireland ETF (EIRL) in the process of resolving higher and completing a seven-year base relative to the All-World Ex-US ETF (VEU).

Not only are European stocks leading the way higher on an absolute basis, they’re also outperforming in relative terms.

If and when we get a decisive breakout from this base, Irish stocks could assume a leadership role over longer timeframes.

4/ Will Crypto Catch Down?

There is a strong positive correlation between cryptocurrencies and stocks, particularly growth stocks. After all, both are risk assets.

The overlay chart below of Bitcoin and the S&P 500 shows just how tight of a correlation these assets have had over the past year:

In recent weeks, however, we’ve seen them move in opposite directions. While Bitcoin has been resilient and achieved its highest level since June earlier this week, stocks have been under pressure, with the S&P 500 hitting its lowest level since late January yesterday.

The breakdown in the relationship between these two assets is shown by the short-term correlation coefficient (shown in the lower panel) turning negative recently. While this does happen from time to time—like back in November—it is rare.

It’s unlikely that stocks and cryptocurrencies will move in opposite directions over the long run. The question now becomes whether Bitcoin will catch down, or whether stocks will catch up.

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Originally posted 23rd February, 2023