From everything we’re currently seeing, I believe the potential trend reversal I’ve been pointing out for the past couple of weeks is beginning to take shape. Yes, we could see a brief rally… but the S&P 500 should be lower a month from now than it is today.

Here’s how I came to this conclusion…

Once again, I want to start with a look at the seasonal trend in SPDR S&P 500 ETF (NYSE: SPY). Now, it’s worth reiterating what I’ve been saying for the past couple of weeks when we talk about seasonals. While seasonals should not be the sole reason to take action in the market, it’s a very useful input to consider alongside other indicators.

So far this month, tracking SPY’s seasonal trend (blue) has been working fairly well, with the ETF’s current price action (black bars) closely following the projected movement.

As you can see in the chart, SPY’s seasonals remain weak into the end of the month. And the weak seasonal outlook for the next few weeks combines with fears of inflation and a potential earlier-than-expected increase in interest rates.

The Fed’s Role In The Market

After last week’s Federal Reserve meeting, the Fed updated its economic projections. In that report is the Fed’s “dot plot,” which is widely followed by investors, analysts, CEOs, politicians, and pretty much anyone hoping for a sneak peak of what interest rates will look like in the coming quarters.

Essentially, the “dot plot” shows projections for the federal funds rate, which largely determines the interest rates consumers and institutions will pay. Each yellow dot on the chart represents where one of the Fed policymakers believe rates will be at the end of each year shown.

The most recent dot plot is shown below.

Source: Bloomberg

The median value of the dots — the midpoint of the Fed’s projections — is shown as a green line. The lighter colored line shows the rate expected based on prices of futures on fed funds. This latest chart shows significant changes from the March dot plot. Back then, just four of the 18 Fed officials expected there to be a rate increase in 2022. But now that number has increased to seven.

Looking forward to 2023, 13 Fed officials expect at least one rate increase, up from seven officials just three months ago. A majority (11) expect two rate hikes by the end of 2023.

Higher rates are a response to higher inflation. The Fed’s projections now show expected inflation of 3.4% this year, a full point higher than the March forecast. The 2022 forecast rose to 2.1% from 2%, and the 2023 estimate was raised to 2.2% from 2.1%.

The Fed also expects faster economic growth. GDP should grow 7% this year, up from a prior projection of 6.5%. But projections for next year were unchanged at 3.3%, indicating the Fed expects long-term challenges for the economy.

While the shifts in the Fed’s outlook were significant, the market expects even higher rates. That could be bearish for stocks because investors could be tempted to sell stocks if bonds offer reasonable returns. This is a long-term concern for the market that could be driving the short-term selloff we saw last week.

How This Affects The Way We Trade

That selling leaves the chart of SPY in a precarious state. Let’s take a look at my next chart, which is also showing weakness.

The first thing I want you to look at on this chart is the months-long trading range (dashed lines) I’ve highlighted in the upper right section of the chart. SPY had a small breakout two weeks ago, closing above the upper dashed line, which would normally be a bullish sign. However, at the beginning of last week, I noted that my indicators were all suggesting that this was actually a “false breakout,” or when a breakout is followed by a rapid reversal. That’s exactly what we got, with SPY dropping 2.2% by the week’s close.

My Income Trader Volatility (ITV) indicator, shown in the bottom panel of the chart below, is now near a “sell” signal.

ITV (red) is similar to VIX in that it rises as prices fall. So seeing ITV trending up, like it is now, is a sign of growing weakness. Its current position, just below its moving average (blue), points to potential selling in stocks.

Our last chart this week shows my Profit Amplifier Momentum (PAM), which may be pointing to even more declines.

PAM is designed as a short-term indicator. The red bars are bearish, and the green bars are bullish. Currently, PAM is declining from a peak, which is another potential indicator of weakness.

Closing Thoughts

Despite evidence that a downturn is on the horizon, I don’t want you to panic. There are plenty of ways to profit and/or protect capital in a downtrend — you just have to be willing to look at alternatives to simply “buying stocks.”

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