How serious is the market’s trend break?

Preface: Explaining our market timing models

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.
 

What rotating correction?

It finally happened. I’ve been warning about the extended nature of the market advance since late January, and the pullback seems to have begun. The S&P 500 violated a rising trend line that stretches back to November last Thursday. Friday’s market rebound didn’t help as it left the index below the rising trend line.
 

Trend breaks everywhere

From a technical perspective, the break in the S&P 500 trend line is a signal of significant technical damage. In addition to the S&P 500, I am seeing breaks in rising trend lines or channels everywhere.
The semiconductor stocks, which are bellwethers of the AI-related boom, violated both absolute and relative trend lines.
 

The price momentum factor, as measured by the relative performance of momentum ETFs, are beginning to roll over.
 

Even most versions of the Advance-Decline Lines are breaking their uptrends.
 

Taken in combination, these trend breaks are indications that a risk-off episode is about to begin.
 

Buy the dip

However, investment-oriented accounts should view any weakness as an opportunity buy the dip. The usually reliable monthly MACD histogram of the NYSE Composite turned positive in June 2023, which has been a reliable signal of a long-term bull market.
 

I would also monitor the relative performance of large-cap growth stocks. The AI transformation is real and it’s only in the early stages of adoption. Investors should seize any opportunity to buy these stocks if the normalized relative performance of the NASDAQ 100 (black line) dips into the oversold zone.
 

 

 

Bullish tripwires

I would warn that it’s a little early to be buying the dip. I would like to see sentiment turn sour and panic, which isn’t in evidence just yet.
 

 

A sign of a tradable bottom is an oversold condition in the Zweig Breadth Thrust Indicator. The ZBT buy signal is triggered when the market moves from oversold to overbought within 10 trading days. While those occurrences are rare, the ZBT Indicator is nevertheless a useful sign of an oversold extreme.
 

 

Another sign of a short-term market bottom is insider activity. Insiders flashed a prescient buy signal when buys exceeded sales in late October. The rest, as they say, is history.
 

 

It’s possible that the pullback could be fairly shallow. One of the five of my tactical bottom spotting indicators have flashed a bottoming signal. The VIX Index recently spiked about its upper Bollinger Band. Other models that are getting close to a buy signal are the term structure of the VIX is flattening very quickly and could invert soon, and the NYSE McClellan Oscillator, which could become oversold soon. Historically, downside risk tends to be limited when two or more models that flash buy signals.
 

 

On the other hand, the chart of the 2-year Treasury yield, which is a proxy for Fed Funds expectations, shows a cup and handle pattern on the verge of an upside breakout. Should it break out, upside potential could be significant and could have severe bearish implications for equity prices. Next week’s release of the FOMC minutes could shed greater clarity on rate expectations and the direction of the 2-year yield.
 

 

In conclusion, multiple breaks in rising trend lines are signs that a risk-off episode is underway. Initial support for the S&P 500 can be found at the 50 dma at about 5080, with secondary support at the NVIDIA earnings report price gap at around 5000, and strong support at the breakout turned support at about 4800.
I am long-term bullish and investment-oriented accounts should regard weakness as a buying opportunity. I have outlined a number of bullish tripwires based on sentiment and technical indicators for investors to follow.

My inner trader remains tactically short the S&P 500. The usual disclaimers apply to my trading positions.

I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.

Disclosure: Long SPXU