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In response to the recent steep pullback in stocks from their August highs, our Market Outlook last week focused on how uncertain and potentially volatile September (and October) can be to the stock market.

What prompted this week's rally? There are various drivers of the positive action.

Oil prices have been falling quite steeply. This will help take pressure off the escalating inflation picture. After hitting a high of $120 a barrel in June, oil prices have declined by about 30% to the low $80's. Some of this is due to seasonality, demand destruction (people are not driving as much), and a global slowdown (especially in Europe) which has caused additional supplies to come online.

As you can see in the chart above, the price of oil is below both the 50- and 200-day moving averages. In fact, the 50-DMA crossed below the 200-DMA on Friday, which is viewed as a negative indication for future oil prices.

Oil's trend is bearish, but this has helped relieve some inflationary pressure, which in turn is a net positive for the stock market.

Many commodities have declined in price. DBC is an ETF that tracks a basket of commodities, including oil and gas, softs (i.e., corn, soybeans, wheat, and sugar), gold, silver, and industrial metals (i.e., copper, aluminum, and zinc). Materials such as copper and lumber have fallen due to the sharp decline in housing construction.

Interest rates have had a volatile summer. 10-year Treasury bond rates peaked in mid-June, then pulled back substantially (which spurred the June to early August stock rally). After Fed Chairman Powell's infamous breakfast remarks at Jackson Hole in late July, the 10-year interest rate rose quickly again.

During the last three days of the week, bond prices consolidated, which benefited the stock market.

We experienced an oversold stock market which was due for a bounce. Many of the sentiment readings were extremely negative, and the momentum indicators (RSI) were also deeply oversold. As a result, it was not surprising to get a significant bounce after three negative weeks.

Transportation, small-caps, and retail stocks, all important members of Mish's Modern Economic Family, have held up above their all-important 50-day moving averages. This has signaled a potential bounce coming.

What conclusions can we derive from all of this? None.

Headwinds Remain

We remain in a bear market (or at least not a new bull market), and we remain in a difficult market period of the year (September-October).

What are the other headwinds that potentially lie ahead?

1. The upcoming midterm elections: Anticipation of one party or another having control of Congress may derail the markets. This midterm cycle has typically signaled a difficult period before November. Given the divisive nature that exists today, this could be exacerbated this year by the aggressive jawboning that takes place.
2. Upcoming Fed meeting later this month: It is widely expected that the Fed will raise rates 75 bps (third month in a row for this steep of a raise). However, if they only raise 50 bps (not likely), it may signal to the markets that the economy is decelerating much faster than expected.
3. Hawkish Fed Speak: Several Fed Governors have been actively commenting about the need to keep tightening. Most have said interest rates must continue going higher to stop inflation. This is likely to continue leading up to their next meeting in late September. This will continue to have an influence on market activity, good and bad.
4. Negative macro-economic numbers: Upcoming CPI (Consumer Price Index), ISM, Consumer Sentiment readings, indications of third quarter GDP, jobs numbers including unemployment claims, and a host of other indications of the strength or lack thereof of the economy may serve as headwinds.
5. Recent large flows of money out of the stock market: Some funds, like ARKK (Ark Technology Fund) have seen record number of outflows during the month of August.
6. Geopolitical surprises and inflation: Oil and natural gas are just a few of the pawns being used as countries try to control other countries. Meanwhile, soft commodities are still strong and could be in a longer-term super-cycle. Gold, silver, and industrial metals are also poised to rally from their near 100-year lows relative to equities.
7. Chinese aggressive action: US-China relations are not positive right now. This could impact our reliance on goods and services from the far East.
8. Dollar strength: This has already curtailed large multinational companies' earnings growth. This alone should drive earnings down and negatively affect the markets.
9. Downward revised earnings expectations: Analysts have been cutting their corporate earnings expectations due to a combination of higher fixed and variable costs (materials and labor), a slowdown in consumption, and dollar strength which lowers export expectations. Problems in Europe are also having somewhat of a contagion effect.
10. Potential housing slowdown: While not yet a "crash," housing activity is down significantly. This is due to higher interest rates and bubble-like housing prices in many markets, making housing increasingly unaffordable. If this area of the economy picks up speed, it will have a detrimental effect on consumer spending and, ultimately, investing in the stock market.

Here are additional points of relevance.

Risk-On

• All 4 key US indices closed at or above their 50-day moving averages, transitioning into a recovery phase while not becoming overbought according to either price action or momentum.
• The IWM is the strongest real motion pattern amongst the major indices because the 50-DMA has crossed back above the 200-DMA, looking likely to also be the first index to retest resistance at its longer-term 200-DMA on price after leading the most recent rally.
• Every sector was green on the week, being led by consumer discretionary (XLY), up 4.8%, while consumer staples (XLP), up 0.6%, performed the weakest, a risk-on indication.
• Market internals for both the S&P 500 and Nasdaq Composite drastically improved this week, with the McClellan Oscillator bouncing from deeply oversold territory and back to almost neutral levels.
• Market internals, as measured by the number of 52-week highs/lows, turned positive from oversold levels for both the S&P 500 and the Nasdaq Composite, a historical indication for short-term bottoms.
• According to the number of stocks within the S&P 500 and Russell 2000 that are above key moving averages, SPY is mildly overbought in the short-term, but it is still leading over IWM in regards to its longer-term recovery, with the number of stocks above the 50-day moving average above 50% for SPY.

Risk-Off

• The yield curve remains inverted, which is still a recessionary indication.
• Soft commodities held up well above their 50-day moving average, and they are still outperforming the S&P 500 on a short-term basis, with copper (COPX) also breaking out above its 50-DMA and outperforming. These are clear signs of lingering inflationary pressures.
• Despite the runup over the past few days, volume failed to confirm the move and is still showing more distribution than accumulation days over the past two weeks.
• Commodities were the clear hotspot this week, led by gold miners (GDX), up 8.6%, palladium (PALL), up 8.2%, metals & mining (XME), up 7%, and oil services (OIH), up 6.9%.
• Treasury bonds (TLT) made another new low with pressure on interest rates across the board, especially following the influence of the European Central Bank's 0.75 bps hike on Thursday.

Neutral

• Risk gauges improved from negative back to neutral territory this week.
• The short-term vs. long-term volatility ratio improved from a negative to a neutral reading.
• Both value stocks (VTV) and growth stocks (VUG) improved above their respective 50-day moving averages this week, with VTV already making strides towards testing its 200-DMA. However, there is a potential rollover in this relationship that could result in growth leading.
• Foreign equities are underperforming US equities across the board.
• Gold (GLD) looks to be potentially putting in a double-bottom on both price and momentum, according to real motion, and it is now back above the 10-day moving average for the first time since early August. Gold also looks to be bouncing off its significant 200-week moving average and from the bottom of an 18-month range.
• Although the US dollar made a new high this week, it looks to be overbought and is losing momentum over a longer-term basis, according to real motion.

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