Mid-week market update: The S&P 500 had been on an upper Bollinger Band ride, but the ride may be over. In the past year, such events have resolved themselves in either a sideways consolidation or pullback. As well, the 14-day RSI has reached levels consistent with a pause in the advance.
Based on recent history, we should know about the magnitude of the pullback within a week. Initial support can be found at the breakout level of about 4540.
Regardless of the scale of any stock market weakness, the intermediate-term outlook remains bullish. There is nothing more bullish than fresh highs, and the Dow recently punched its way above resistance to an all-time high. The Transports have surged to test resistance but weakened. Further gains in this index would constitute a Dow Theory buy signal.
Market breadth is showing signs of strength. The S&P 500, NYSE, S&P 400 Advance-Decline Lines reached all-time highs. Only the NASDAQ and S&P 600 A-D Lines are weak. These are signs of broad underlying strength, not weakness.
To be sure, small-cap indices are struggling with resistance and they have not staged upside breakouts and they are weak relative to the S&P 500. However, relative breadth is improving (bottom panel) and we are entering a seasonally positive period where small stocks should enjoy some tailwinds.
Sentiment not extreme
Sentiment readings are supportive of further gains. The latest update from Investors Intelligence shows that % bulls are recovering, but % bears remain stubbornly high. There is much more room for sentiment to improve before they reach an overbought extreme.
Bullish and bearish catalysts
I interpret these conditions as conducive to further gains after a brief pause. Possible catalysts for either upside or downside volatility could come from the FOMC meeting next week. The Bank of Canada sounded a hawkish tone today by announcing the end of quantitative easing and pulling forward the calendar for rate hikes. The Canada yield curve went bonkers. 2-yield yields rose the most and the curve flattened in response. While recent Fedspeak has signaled the start of tapering, the risks is next week’s policy response will be skewed hawkish.
As well, a deal for the Biden fiscal plan may be close this weekend. While a general corporate tax increase is off the table, a 15% corporate minimum tax could be passed. Such a measure would negatively affect Big Tech and pharmaceutical companies with intellectual property held in subsidiaries resident in low-tax jurisdictions.