More short term bearish signs and medium term bullish signs for stocks


The stock market has gone nowhere over the past 3 days. The S&P 500 is stuck at its 2800 resistance after a record breaking rally.
Meanwhile, various signs of short term complacency are creeping back into the market.

Go here to understand our fundamentals-driven long term outlook.
Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day.

*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are blindly “guessing” the future.

Low volume

The stock market’s strong rally has been accompanied by falling volume. Traditional technical analysis states that “rallies accompanied by falling volume” are bearish.
Is this true?

Here’s what happens next to the S&P when $SPY (S&P 500 ETF) rallies more than 10% over the past 10 weeks, while SPY’s volume falls more than -50%

This is a short term bearish sign for stocks over the next 1 month.

Put/Call

The Put/Call ratio’s 10 day moving average is now -13% below its 200 day moving average. This demonstrates some short term complacency in the stock market.

Historically, this was a short term bearish sign for the S&P over the next 2 weeks.

Cyclical vs Defensive

Several articles on CNBC, Bloomberg, and financial media have focused on cyclical sectors’ outperformance and defensive sectors’ underperformance.
XLI (industrial sector) has rallied more than 25% while XLU (utilities, a defensive sector) has rallied less than 10% since the stock market’s bottom on December 24, 2018.
From 1998 – present, the only other time this happened was in mid-2009.

It does appear that cyclicals leading defensives is a good sign for stocks.

Return of low volatility

Low daily volatility has returned to the stock market. The 20 day average of the S&P’s daily change is now less than 0.5%

Here’s what happens next to the S&P when low volatility returns to the stock market after more than 4 months.

Not consistently bullish or bearish for stocks on any time frame.

NASDAQ’s breadth

Like the S&P’s breadth, the NASDAQ’s breadth is remarkable.
The NASDAQ McClellan Summation Index’s current reading is matched only 2 other times from 1998 – present:

  1. 2003
  2. 2013


Both of these historical cases were bullish for stocks over the next year.

XLY:XLP

The XLY:XLP ratio (consumer discretionary vs. consumer staples) has gone nowhere while the stock market rallied from early-January to present.

This is uncommon. The XLY:XLP ratio tends to move inline with the S&P when the S&P rallies so much in such a short span of time.
Here’s what happens next to the S&P when it goes up more than 8% over the past 31 days, while the XLY:XLP ratio doesn’t rise.

The sample size is small, and this is not consistently bullish or bearish for stocks on any time frame. However, it’s clear from looking at the dates that this occurs around major inflection points in the stock market:

  1. 2011 (S&P fell -20%)
  2. 2009 (bull market bottom)
  3. 2007 (bear market top)
  4. 2002 (bull market bottom)
  5. 2001 (bear market rally’s top)
  6. 1999 (less than 1 year before the bear market began).

March

With March just around the corner, here’s a quick reminder of the stock market’s seasonality.


Click here for yesterday’s market study

Conclusion

Here is our discretionary market outlook:

  1. The U.S. stock market’s long term risk:reward is no longer bullish. In a most optimstic scenario, the bull market probably has 1 year left. Long term risk:reward is more important than trying to predict exact tops and bottoms.
  2. The medium term direction (e.g. next 6-9 months) is more bullish than bearish.
  3. The stock market’s short term has a bearish lean due to the large probability of a pullback/retestFocus on the medium-long term (and especially the long term) because the short term is extremely hard to predict.

Goldman Sachs’ Bull/Bear Indicator demonstrates that while the bull market’s top isn’t necessarily in, risk:reward does favor long term bears.

Our discretionary outlook does not reflect how we trade the markets right now. We trade based on our quantitative trading models. When our discretionary outlook conflicts with our models, we always follow our models.
Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.
Click here for more market studies