Preface: Explaining our market timing models
The latest signals of each model are as follows:
- Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
- Trend Model signal: Bullish (Last changed from “neutral” on 28-Jul-2023)
- Trading model: Neutral (Last changed from “bearish” on 03-Aug-2023)
Update schedule: I generally update model readings on my site on weekends. I am also on Twitter at @humblestudent and on Mastodon at @email@example.com. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.
Subscribers can access the latest signal in real time here.
A correction in an uptrend
No signs of panic
So far, the pullback has only begun, and there are few signs of panic that mark buying opportunities. The Fear & Greed Index is still at a greedy reading.
Tactically, VIX Index term structure is not inverted, which would be a sign of fear.
The usually reliable S&P 500 Intermediate Term Breadth Momentum Oscillator (ITBM) flashed a sell signal last week when its 14-day RSI recycled from overbought to neutral. What makes this episode stand out is the sell signal occurred against a backdrop of the percentage of S&P 500 stocks bullish on P&F charts turned down from above 80% to neutral, indicating a sell signal from a severely extended condition.
There were only four other episodes in the last five years. In all of them, the market decline didn’t stop until the NYSE McCellan Oscillator (bottom panel) reached an oversold condition. As well, the 14-day RSI of ITBM (top panel) reached an oversold reading in three of the four occasions, and the last one was close. In the case of the major downdraft that began with the sell signal of August 2022, indicators reached an initial oversold reading and the market bounced before resuming its decline into its ultimate low.
In addition, the 5-week RSI of the S&P 500 reached an overbought extreme in June. The last two times this happened the decline wasn’t arrested until RSI reached a neutral reading of 50, which could be as low as the S&P 500’s long-term support at about 4200.
However, the pullback may not necessarily be that severe. The 5-day RSI of the S&P 500 is already oversold. Initial support can be found at the 50 dma at about 4400, with secondary support at 4200. If that support breaks, look for a test of the 200 at about 4100.
Despite the short-term dominance bearish price momentum, I am still constructive on the stock market. Market leadership has broadened out from the narrow leadership of megacap technology stocks, which is helpful to the bull case.
The relative performance of key cyclical industries is either bottoming or in a relative uptrend, both are signals of a bullish cyclical rebound.
Finally, keep an eye on the Dow Jones Transportation Average, which exhibited an inverse head and shoulders breakout. If this is indeed just a short-term correction, the index should hold above its breakout level.
In conclusion, the stock market had been undergoing an unsustainable advance and a corrective period has probably started. I believe this is just a pullback within the context of an intermediate uptrend. I offer several clues on how to spot the corrective bottom.