Get Ready to Buy the Dip, But Not Yet

In the past few weeks, I have been warning about the short-term vulnerability of the stock market’s advance. I cited numerous cases of negative divergences. Last week, the S&P 500 printed three consecutive red days before reversing on Friday. It’s unclear whether this was the start of a correction, as the equal-weighted S&P 500 remains above resistance turned support. However, the pullback briefly left it oversold on the NYSE McClellan Oscillator (NYMO).

You can nevertheless feel the tone of market psychology changing. Enthusiasm over the prospect of further Fed rate cuts has moderated, and geopolitical risk premium has risen in the wake of Ukrainian strikes on Russian oil facilities and European threats to Russia. If this is the long-awaited pullback, is that all there is? How bullish or bearish should investors and traders be?

Notwithstanding any concerns about short-term wiggles in U.S. stock prices, I remain intermediate-term bullish. MyTrend Asset Allocation Model score is based on a composite of global stocks and commodity prices, and I see few signs of a major market top.

A review of global equity markets ex-U.S. reveals signs of strong global breadth. Topping markets simply don’t behave this way.
 

 

As well, global monetary policy has shifted to an easing cycle, which should be supportive of higher stock prices.
 

 

To be sure, the 2-year Treasury yield, which is a proxy for the market’s estimate of the Fed Funds terminal rate, has risen since the Fed cut rates by a quarter-point, and so has the 10-year yield. As well, gold prices have also surged in the face of a flat to slightly positive USD Index. I interpret this to mean that the markets are discounting a reflationary boom, which is positive for earnings and stock prices.
 

 

S&P 500 forward 12-month EPS estimates continue to rise, which indicate positive fundamental momentum.
 

 

What have you got to worry about? Investors should view signs of weakness as an opportunity to buy the dip.
 

 

How Deep a Pullback?

However, if this is the long-awaited market pullback, I believe any damage will be deeper than the weakness shown last week.

Sentiment indicators are still neutral and not flashing a contrarian buy signal. The AAII bull-bear spread came in last week at +2.5, which is on the slightly positive side of neutral.
 

 

The NAAIM Exposure Index, which measures the sentiment of RIAs who manage individual investors’ funds, edged up last week and shows no signs of panic.
 

In the meantime, IPO stocks hit an air pocket after reaching a zone of relative resistance. This is a sign of the market’s animal spirits in retreat. The froth is coming out of the market.
 

 

As well, the SMID Advance-Decline Lines are behaving abysmally, indicating further downside potential. Further weakness in small- and mid-cap stocks will have negative breadth implications for the market.
 

 

What about the oversold reading shown by NYMO that I highlighted? NYMO is one of the five components of my Bottom Spotting Model, and it’s the only one that’s triggered so far. In the past, I  need two or more components to flash buy signals before tactically turning bullish. Sentiment hasn’t panicked and the market isn’t at an oversold extreme. It’s too early to call a trading bottom.
 

 

In conclusion, I remain intermediate-term bullish on stocks, but the market is at risk of a correction. If last week’s weakness is the start of a pullback, short-term trading indicators point to further downside potential. Investors should be prepared to buy the dip, but not yet.