Is Fed Pushing Stock Market Capitulation?

In Stratego, a military-inspired board game, the natural strategy is to fight through the front lines, take out rear support, and then take down the generals before capturing the flag.

This stock market, according to one trader, is shooting at the generals and marching toward taking out stronghold equities. The flag of a stock market capitulation may be in sight.

The market generals are the once seemingly invincible mega cap technology stocks.

Market, FAANG stocks face capitulation

Stock market capitulation lies ahead, despite a collective world of positive media pundits and analysts, according to Sam Shames, Vice President of Options at Simpler Trading.

He has watched this arguably comedic tragedy unfold throughout 2022.

“Why is this important?” Sam queried his newsletter audience. “Historically bubbles end in the same way.”

Like the board game analogy, the stock market blew out the front lines like cryptocurrency and the high-value, ARK Innovation Exchange Traded Fund (ARKK); then took out the mid cap valuation stocks; and now is aiming at the generals – FAANG stocks.

FAANG stocks refer to high valuation technology companies that include Facebook (now Meta), Amazon, Apple, Netflix, and Google (now Alphabet).

These once untouchable stocks are holding up the indexes, Sam explained. FAANG stocks could be considered the flags that fall as the stock market bubble implodes.

“This is where we appear to be now and it is important to note from both a timing perspective as well as a positioning perspective in that these once ‘safe’ stocks will no longer be safe,” Sam said. “We’re closer to the end than before, although very far away still.”

Having the final act in sight is a call to caution for traders.

“To borrow a term from the great Jeremy Grantham, this all leads to the ‘Grand Finale,’” Sam said. “The final leg down which creates capitulation of the bubble that was.”

Grantham, a famed long-term investment strategist, holds that this final act encompasses the housing, equities, and bond markets colliding. A similar comparison, according to Sam, would be the housing and financial crash of 2008.

Sam acknowledges that some would say this is a premature assessment of the stock market environment and where it’s headed.

“But ask yourself, who has been right?” Sam pointed out. “Those that told you to sell a year ago or those that are providing hope while every chart of significance crumbles.”

Don’t fight Fed actions with hope

Sam encouraged traders to play their own devil’s advocate against anyone heralding promising headwinds in the near future.

He shared his assessment of the iShares TIPS Bond ETF (TIP) and how it relates to the SPDR S&P 500 ETF Trust (SPY). TIP represents inflation expectations while the SPY represents 500 large-cap U.S. stocks. He pointed to the daily chart on these two funds showing the TIP has already broken June lows.

“My thesis is that TIP is leading SPY,” Sam said. “If so, that not only implies that the June lows will not hold, but also that the 200-day simple moving average weekly will not hold. And, a retest of the Covid lows (March, 2020) is possible as that is where TIP appears to be heading already.”

Even if his thesis is only partially correct, Sam said it should give traders pause when considering long swing trades versus day trades.

A Federal Reserve (Fed) announcement of higher benchmark interest rates on Wednesday could impact Sam’s outlook. The Fed is expected to raise rates by 75 basis points, or higher.

“Let us not fight the trend or the Fed with hope,” Sam said. “Hope is the one four letter word that is not allowed.”

Deflation next worry for economy, traders

Sam encouraged traders to consider Fed actions that could lead to a deflationary economic environment.

“Once the process of deflation kicks in, which is what the Fed is without question trying to spur now… it is wildly difficult to reverse,” Sam said.

He noted how the Fed is in a precarious situation trying to combat interest rates without crippling the economy.

“Remember this, unlike every time before where the Fed swoops in to rescue the markets, this time the Fed is out of ammo,” Sam said. “There is nothing they can do to ‘save the world’ again… at least not until they reload their gun by raising rates much higher.”