The Market Mosaic 5.7.23
Can the S&P 500 keep rallying?
Welcome back to The Market Mosaic, where I gauge the stock market’s next move by looking at macro, technicals, and market internals. I’ll also highlight trade ideas using this analysis.
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Now for this week’s issue…
It doesn’t matter if you are bull or bear. Last week featured something to support your views either way.
When the Federal Reserve came out and hiked rates another 0.25% (see the fed funds chart below), their accompanying statement omitted the language “additional policy firming” seen in prior meetings.
But while it seemed a bullish pause was in the works, Fed Chair Jerome Powell delivered a bearish message that rates would be held higher for longer and even describe the U.S. bank system as sound and resilient. The perceived lack of concern over the bank crisis that emerged in March sent bank stocks crashing and the rest of the stock market careening.
Then came the most recent labor market report. With 253,000 jobs created in April along with the unemployment rate falling to 3.4% (long-term chart below), the report smashed expectations. The bearish take for stocks is that a strong labor market reinforces the Fed’s need to maintain restrictive policy.
But ultimately the bulls were rewarded with the S&P 500 gaining 1.9% the day the report was released. Labor data shows the economy performing just fine in the wake of bank sector turmoil and concerns that the Fed is pushing rates too far.
Following the ups and downs, the S&P 500 ultimately finished with a loss of 0.8% for the week. And for traders, the conflicting economic data and mixed stock market reaction can be maddening when deciding on new positions and sizing of trades.
Instead of agonizing over every news bite and market reaction, this is why I view the market through an objective lens of market internals and trends.
So lets look beyond last week’s events, and see what the weight of the evidence says about the stock market.
A Mixed Outlook for Stocks
I evaluate the intermediate-term outlook for the stock market by analyzing the intersection of the market’s trend along with breadth and sentiment indicators.
A rally supported by a strong foundation and skeptical (or bearish) investors is what I’m after to position size my trades more aggressively. On the other hand, a rally supported by fewer stocks along with exuberant investors is when I become more cautious.
Right now, the stock market’s trend seems to be holding up just fine. The S&P 500 is trading above all key moving averages and is turning back up toward the 4200 level. That’s key resistance tested several times since late August as you can see below.
But on the rally that’s unfolded since mid-March, participation in the stock market’s trend has been weakening. Just take a look at the percent of stocks trading above their 50-day moving average across the market. While the S&P 500 is back to similar levels seen in early February, only 42% of stocks are in uptrends compared to 80% in February.
I also like to track breadth by utilizing a moving average signal on the McClellan Summation Index. This metric nets out advancing versus declining stocks on the New York Stock Exchange over a trailing period. I look for bullish or bearish crossovers to signal growing or weakening participation in the stock market’s trend. And you can see in the chart below, that the oscillator is still stuck in a bearish cross that occurred in late April.
At the same time, investor sentiment is more mixed in trying to determine the bullishness versus bearishness of investors. CNN’s Fear and Greed Index has swung back to greed, meaning it’s time to become cautious as a contrarian indicator.
But that index is comprised of market based indicators, like the Volatility Index (VIX) and put/call option data. If you straight up ask investors how they feel, like with the AAII survey of individual investors, the mood is growing more bearish (AAII sentiment table below) which is a good thing.
To summarize, if the S&P 500 is able to take out resistance at the 4200 level I will want to see a quick improvement in breadth on the upside. Friday’s strong daily reading on the advance/decline ratio, which was 6.5 to 1 for the NYSE, is a good start. But more strength is needed for the average stock to catch up to the major indexes.
The metrics above are useful for plotting the stock market’s course over the next few months. I also supplement that analysis by looking at the message coming from other asset classes and cyclical stock market sectors that are sensitive to economic developments.
That includes high yield bonds, where I’m tracking an important pattern with the JNK exchange traded fund (ETF) that you can see below. I also wrote about this triangle pattern last week, and wanted to provide an update as price nears the apex of the two trendlines as you can see below.
Resolution will speak volumes about risk sentiment in the stock market, and if the woes plaguing the bank sector are starting to spillover to the broader stock market given the sensitivity of high yield investors to a deteriorating economic outlook. If the S&P can rally above 4200, I’m looking for confirmation with an upside breakout in JNK.
I’m still being more cautious on position sizing, but taking trades that meet my criteria. And one of the most interesting sectors for breakouts is with gold miners. Even with gold prices stalling out at all-time highs on Friday, many gold mining stocks are starting to breakout of basing periods with relative strength (RS) lines making new 52-week highs.
That includes with FNV, where I’m looking for a breakout over the $160 level. I would note that the RS line hit the highest level in nearly three years last week.
I also posted about the setup in AQUA. The stock has been consolidating right around the prior highs near the $50 level. It’s now moving over that resistance area along with increased volume and new highs on the RS line.
That’s all for this week. We’ve finally put a few key catalysts in the rearview with the Fed and payrolls. We’re also past the bulk of earnings season with 85% of the S&P 500 having reported. If that means less turbulent air ahead for stocks, I’m looking for a quick improvement in breadth in order to trade more aggressively.
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Disclaimer: these are not recommendations and just my thoughts and opinions…do your own due diligence! I may hold a position in the securities mentioned in this report.