Stock Market Looks Due For A Pause (Or A Pullback)

Stock Market Looks Due For A Pause (Or A Pullback)

The stock market is looking a little tired and extended here. Despite seasonal bullishness, I’m expecting a pullback that could last a week or two and take the S&P down 4-6% from its highs.

These are the developments that have got me thinking about this possibility

1. We’ve reached – and stopped at – some Fibonacci extension targets on declining momentum

In the chart below, you can see the S&P 500 has hit the 1.618 extension target from the previous all-time high on 2nd September to the 4th October low. The new all-time high on 22 November hit the 1.272 extension of the more recent minor pullback to the tick. The new high was made on declining volume

Stock market makes a new high at an extension target on declining momentum
S&P 500 makes a new high at an extension target on declining momentum

It’s a similar story with the Nasdaq – new highs right near extension targets on declining momentum.

Nasdaq makes a new high near extension targets on declining momentum
Nasdaq makes a new high near extension targets on declining momentum

2. The S&P 500 is again bumping its head against the upper trend line

The S&P 500 has run into its upper trend line that has contained price for the past 14 months. If we don’t get a parabolic rise here, a stock market pullback remains a higher probability.

Stock market has run into its upper trend line
S&P 500 has run into its upper trend line

3. Market breadth remains questionable

The recent new high in the S&P 500 was not confirmed by the advance-decline line:

Divergence between the S&P 500 and the advance decline line
Divergence between the S&P 500 and the advance decline line

We are also seeing a small divergence between the market capitalization weighted S&P 500 ETF – SPY, and the Equal Weight ETF – RSP:

Divergence between SPY and RSP
Divergence between SPY and RSP

This indicates recent stock market gains have been concentrated in the MAFANG stocks (+Tesla!)

Small cap stocks – as reflected by the Russell 2000 ETF, IWM – are also diverging from the major stock market indices:

 Small cap stocks have already broken down
Small cap stocks have already broken down

4. A number of “risk on” barometers have fallen quite hard recently

Take a look at sectors like cloud computing (SKYY or CLOU), Bitcoin, the IPO ETF, the high beta ARKK ETF…all have taken a recent beating. This is indicative of waning confidence and a reduction in risk appetite. Whether this spills over into the Apples and Microsofts of the world remains to be seen, but this is a warning of shifting risk sentiment.

5. Everybody is already long

The recent BAML Global Fund Manager Survey shows fund managers are the most overweight US equities in 8 years. As the chart below shows, the stock market struggles to continue advancing when consensus becomes this lopsided.

Everybody is already long the stock market
BAML Survey shows fund managers the most overweight US equities since 2013

Conclusion

I remain (slightly) net long, but I am holding onto some hedges here. If we do get a ~5% pullback over the next couple of weeks, I think that will set traders up for a great buying opportunity into January.

I hope this helps and happy Thanksgiving!

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