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
It’s a similar story with the Nasdaq – new highs right 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.
3. Market breadth remains questionable
The recent new high in the S&P 500 was not confirmed by 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:
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:
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.
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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