Breadth is very strong while stocks are surging. What's next for stock


As the S&P 500 makes a sharp upwards reversal towards its 38.2% fibonacci retracement, the U.S. stock market’s breadth is surging and risk-off assets (USD) are falling.
This combination of extremely strong breadth and a decline in risk-off assets often leads to short term weakness before a bigger medium term rally, but sometimes was a part of V-shaped recoveries. Moral of the story: focus on the medium term instead of the short term. Although V-shaped recoveries are unlikely, there are not impossible.
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.

A sharp reversal

The S&P’s decline was sharp, and its rally recently has been equally sharp. Volatility goes in both directions.

The S&P 500’s 10 week rate-of-change has gone from less than -15% to greater than -4%.
Here’s every single similar case, from 1927 – present

The S&P 500’s pre-1945 data is rather different from post-1950 data. Dividend yields were much higher before the 1950s, which depresses the S&P 500’s nominal price pre-1950s. (In other words, pre-1945 data vs. post-1950 data is an apples vs. oranges comparison). Hence, let’s focus on the post-1950 data

Here, you can see that a V-shaped recovery isn’t impossible.
Macro Context
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Let’s look for events that happened under similar late-cycle instances, when unemployment was under 6%.

Once again, you can see the 1998 and 1987 cases pop up repeatedly.
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VIX

VIX mirrors the S&P. While the S&P crashed and rallied, VIX spiked and then fell.

Here’s what happened next to the S&P when VIX’s 10 week rate-of-change went from greater than 85% to less than -15% (a 100% difference)

Once again, you can see that a V-shaped recovery isn’t impossible.
What happens next to VIX itself
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VIX performs poorly, especially 1 month later.

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NYSE Breadth surge

The NYSE’s breadth has surged. These surges are normal after post-crash bounces. (Breadth is terrible during the stock market’s crash, and since stock market crashes are followed by equally large rallies, breadth is terrific during the rally).


Here’s what happened next to the S&P when the NYSE McClellan Oscillator exceeded 95
*Data from 1998 – present

The stock market’s forward returns are mostly random up to the 3 month point, after which it starts to become bullish.
Macro Context
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Let’s look for events that happened under similar late-cycle instances, when unemployment was under 6%.

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Nasdaq Breadth surge

Similar to the NYSE McClellan Oscillator (NYSE breadth indicator), the NASDAQ McClellan Oscillator (NASDAQ breadth indicator) has surged.

Here’s what happened next to the S&P when the Nasdaq McClellan Oscillator exceeded 80
*Data from 1998 – present

The stock market’s forward returns are mostly random up to the 3 month point, after which it starts to become bullish.
Macro Context
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Let’s look for events that happened under similar late-cycle instances, when unemployment was under 6%.

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U.S. Dollar safe haven

The U.S. Dollar is frequently traded as a safe haven during times of market stress, which is why it went up in 2008 and 2000-2002.
The U.S. dollar has mirrored the S&P 500 recently

  1. When the S&P crashed, the U.S. Dollar Index went up
  2. Now that the S&P is rallying, the U.S. Dollar Index is going down.



Here’s what happened next to the S&P when the S&P’s 10 week rate-of-change went from -13% to -7%, while the USD’s 10 week rate-of-change went from +1% to below 0%
*Data from 1973 – present

You can see that there are large clusters of cases. Let’s look at the first case in 1 month

Once again, while the stock market could face short term weakness over the next 1-2 months, after that there was a bigger medium term rally
What this means for the U.S. Dollar
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This is quite bearish for the USD from a medium term perspective.

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Conclusion

Here is our discretionary market outlook:

  1. The U.S. stock market’s long term risk:reward is no longer bullish. This doesn’t necessarily mean that the bull market is over. We’re merely talking about long term risk:reward. Long term risk:reward is more important than trying to predict exact tops and bottoms.
  2. The medium term direction is still bullish  (i.e. trend for the next 6 months). However, if this is the start of a bear market, bear market rallies typically last 3 months. They are shorter in duration.
  3. The stock market’s short term has a slight bearish lean. Focus on the medium-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 is not a reflection of how we’re trading the markets right now. We trade based on our quantitative trading models.
Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.
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