US equities are heading into what could be a make-or-break week as eagerly anticipated inflation data are due to be released, while the S&P 500 comes up against a significant line of resistance.

Strong Start to 2023

The S&P 500 posted solid gains last month, logging its best January since the pandemic. Meanwhile, the Nasdaq enjoyed its strongest performance for the first month of the year in more than two decades. This is as investors flocked to the riskier end of the investment landscape, having gradually reached consensus that inflation is easing, and that the Fed’s tightening cycle has almost run its course.

This is evidenced by the outflows from inflation-protection ETFs that have continued unabated since September of last year. Meanwhile, Cathy Wood’s Ark Innovation ETF, which specialises in disruptive technology investments, and is regarded as a barometer of high-risk, high-reward, was recently said to have been enjoying the best month in its history.

Retail-Led Rally Catches Out Hedge Funds

Last week, Reuters reported that, according to a Goldman Sachs note, hedge funds have been abandoning their bearish bets at a rate not seen since 2015. Caught wrong-sided by the strength of recent stock market rallies, the resulting short squeeze has forced them into a flurry of short-covering as their negative bets prove to be too expensive to hold. The speed of the recent bout of short-covering is said to have exceeded that of January 2021, when the coordinated activities of retail investors helped push up the prices of troubled stocks like Gamestop and AMC.

Earnings Signal Slowdown

With earnings season almost at a close, a trend that bullish investors have seen fit to overlook thus far is starting to emerge. While most companies have managed to beat the estimates of Wall Street analysts, the percentage of those that missed expectations has risen to the highest level since the pandemic, with more than 25% of companies having provided earnings surprises to the downside. According to Bloomberg, in the fourth quarter of 2022 the per-share earnings of S&P 500 companies were down by 2.3%. This represents the first such decline since the third quarter of 2020.

Technical Hurdles Ahead

In August of last year, a stock market rally that commenced in June saw the S&P 500 surging by almost 20% from a low of 3640, to a high just above 4300. The rally stalled at that level, which also coincided with the index’s 200-day moving average, before retreating to lower-lows. Notably, the rally also failed to stay above the S&P 500’s 50% Fibonacci retracement level, when calculated from the November peak to that swing low of 3640.

Recent stock market performance has seen the S&P 500’s technical picture improving, with all major daily moving averages having been cleared in a bullish direction, as well as a higher-low having been set at 3766 (which also coincides with the 20.3% retracement). The move from 3760 to 4200 has also taken place without the index becoming overbought.

However, taking that same November swing high, and the more recent swing low at around 3500, the recent bullish action has seen the S&P 500 being rejected from its new 50% retracement at around 4160, the retracement percentage at which August’s rally also stalled. When plotted from the respective swing highs and lows of November 2021 and October 2022, that former failed breakout from August 2022 now coincides with a rejection from the 61.8% retracement level.

The S&P 500 is currently trading in a relatively tight range between its 50% retracement as resistance at 4160, and its 20-day moving average as support at 4053.

CPI Data Reveals Inflation Stickier than Expected

Tuesday’s CPI report, while not yielding any big shocks, has revealed that inflation is proving stickier than expected, with year-over-year figures coming in at 6.4%, 0.2% higher than Wall Street’s expectations of a 6.2% year-over-year print. This may give markets pause to consider Fed Chair Jerome Powell’s next move. The story here is of a slight improvement in inflation data, but certainly not what markets may have wanted.

It remains to be seen whether the impetus is there for the above retracement level to be tested and/or broken. A break below the crucial 4000 psychological level could spell the end of the recent bullish trend. Meanwhile, a convincing break above the local high at around 4200, could lead to a continuation.

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