Stock Market Is Near Capitulation As Market Rotation Out From This Sector

As the S&P 500 rose from an oversold state below 3900 to almost 4100 in only four days, many traders and investors speculated about a possible market bottom or at the very least a major rally.

As shown in the video at the bottom of the page, the rebound was predicted to be short-lived, with several scenarios concentrating on price action characteristics to distinguish a bull trap from a market bottom. This was bolstered by the S&P 500's bearish reversal off resistance around 4100 on May 18, 2022.

Stock Market Bottom Requires Capitulation

Capitulation from both institutions and merchants is required to call for a stock market bottom. Prior to market surrender, leadership in sectors, industries, and stocks is likely to fade away, along with market rotation as the smart money exits the market.

Take a look at how the consumer staples sector ETF XLP performed before a market capitulation occured in 2008, as seen below, since the present market pricing structure is remarkably similar to the global financial crisis of 2008, as discussed in my film on the stock market collapse déjà vu.

S&P 500 formed lower highs and lower lows while testing the support-turned-resistance at 1260 from January to September 2008. As XLP attempted to break out to a new high on September 19, 2008 (annotated as 1), S&P 500 formed lower highs and lower lows while testing the support-turned-resistance at 1260.

Increased selling was seen in the volume pane (annotated with a blue arrow) a few days before the breakout effort in XLP failed, which served as a red signal of the breakout attempt. Following a break below immediate support (annotated as 2) with growing volume, XLP failed to rebound and finally capitulated with the S&P 500.

With a steep, broad price spread and rapid trend to the downside, the decline after the swing low created (annotated as 2) was 25% in the S&P 500. On the way down, the volume rose dramatically. Both the price and volume features pointed to a market surrender. Following that, a significant bounce off the oversold situation indicated the selling climax, and a 5-month bottoming process began.

In 2022, as indicated in the figure above, XLP saw a significant selloff, indicating a shift away from consumer staples. This is crucial because XLP is normally the defensive sector, and the smart money rotates out of it last.

Since late April 2022, XLP has seen an increase in selling as seen by the volume, with a failure bar breaking below the support at 78. (annotated as 1). Following the failure, there was a continuation of excessive selling, also known as upthrust after distribution, which is a typical occurrence when smart money unloads long holdings or even initiates short ones.

With growing volume, XLP fell below the support at 76 on May 18, 2022, with the largest bearish bar (annotated as 2) since the Covid-19's bottom, suggesting urgent institutional selling. Because the sequence of events is identical to that of 2008, we should expect a stock market surrender to begin shortly, just as it did in 2008.