Mid-week market update: I have said before that the stock market is extended in its advance and it could pull back at any time. How extended? Here is another metric.
Bollinger Bands (BB) are overbought/oversold indicators. If a stock or index rises above its 2 standard deviation BB. it is said to be overbought. Standard calculations of BBs are based on a 20 dma. It’s unusual to see the market rise up above its upper 200 dma BB. The S&P 500 recently reached 110% above of its upper BB. The history of such episodes (pink bars) show that it usually pulls back soon afterwards. There were only two exceptions since 1997 when the market experienced a sustained uptrend (shown by arrows).
Climate and weather
The market is facing seasonality headwinds, but it’s useful to think about market seasonality as the climate, your actual returns are based on the weather. So far, the weather has been unusually bullish, but it’s also worthwhile to keep in mind market internals for weather indications.
Here are some warnings of stormy weather ahead.
Storm warnings
More warnings are appearing. Bullish sentiment is very stretched. Goldman Sachs recently pointed that the put-call skew shows traders to be all-in on call options and bears have become virtually extinct. The extreme in put/call skew has been exacerbated by a flood of derivative funds enhancing returns by selling put options. This is a “this will not end well” story with no obvious bearish trigger.
Seth Golden, who had been correctly bullish and remains long-term bullish, recently sounded a note of caution about NASDAQ stocks, which had been the leaders of the latest advance. The NASDAQ Hi-Low Logic reached an All-Time High, which is usually a corrective signal.
Bearish tripwires
Here are a few bearish tripwires that I have set. As the latest melt-up has been driven by AI-related plays, the semiconductors are AI sentiment bellwethers. So far, they’re staying in their rising channels. No signs of trouble so far.
Another source of tail-risk that the market isn’t paying much attention to are the problems in office commercial real estate, which is creating problems for regional banks. The regional banking stocks are testing a key relative support level. A downside break could start a cascade of panic selling and instability fears.
Another obvious bearish trigger is an upward inflation surprise. I have discussed the risks of “transitory disinflation” before. Fed officials in recent speeches have all pushed back against the notion that while the Fed is likely done with its hiking cycle, it’s not in a hurry to cut. An upside surprise in the upcoming PCE report could put upward pressure on yields and downward pressure on stocks.
Finally, while it may be prudent to be cautious, there’s no point to be too bearish until the S&P 500 fills in the gap after the NVIDIA earnings report. Until then, the market will either stay in a holding pattern or possibly grind upwards.
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