Bespoke Investment has this post showing the recent market pullback, suggesting that perhaps it is just another 5-% pause within a bullish trend like the previous two.
RBC Capital Markets’ Trend and Cycle argues that “IT IS DIFFERENT THIS TIME” and that the current pullback will likely last months rather than days.
RBC’s views is supported by the market’s overvaluation after its recent bounce (Read my May 7 post EQUITIES: TIME FOR A PAUSE)
S&P; 500 PULLBACK REACHES 5%
The S&P; 500’s pullback from Friday’s intraday high crossed the 5% level today. The current pullback is the third intraday pullback of at least 5% since the rally began on March 9th. With the S&P; 500 on pace for its third straight daily decline (another first for this rally), the current pullback is also the longest.
A key level to watch on the S&P; 500 is 875. The previous pullback in April ended when the S&P; 500 traded down to the level of the March peak. If this decline is anything like the last, we would expect to see support at the peak of the April rally which was 875. If that level fails to hold, the next area of support comes into play at the 50-day moving average (~825).
TREND & CYCLE
IT IS DIFFERENT THIS TIMEWhat makes the current correction different from the pullbacks that developed during the rally from the March 6th lows? Although most market indexes closed below trend line support defined by 15-dma’s, yesterday’s trading was not specifically an inflection point for stocks
but is an extension of a rotation that began 5-7 days ago. The key differences between the current correction and the prior pullbacks in March and April indicate to us that the current pullback will likely last months rather than days. Supporting technical evidence includes:• Relative performance trend reversals developing. During the March and April market pullbacks relative performance trends remained intact. However, an increasing number of relative trend reversals have developed in the past 5-7 days notably to the downside for the NASDAQ, Russell 2000, Consumer Discretionary and Technology sectors and to the upside over the past 2-4 days for traditionally defensive themes such as Staples and Healthcare. These reversals reinforce the case that this pullback is different.
• Weekly momentum indicators are overbought and peaking: Intermediate-term /weekly momentum indicators, which track 1-2 quarter shifts, bottomed in early March but are now showing evidence of peaking. In our opinion this data suggests a period of 1-2 months of consolidation/correction is needed before a suitably oversold technical
condition can develop to support another investable rally.• Most indexes at heavy resistance near 200-dma’s. Almost every market and sector index has rallied from extreme oversold levels back to resistance levels, coinciding with declining 200-dma’s and either the January highs or Q4 highs.
• U.S. long bond yields, most risk currencies and commodities are also at resistance. In general we view the technical behaviour of treasury bonds, risk currencies and commodities as bullish but almost universally they are at levels that will be difficult to surpass without weeks, if not months, of consolidation.
OUTLOOK
• Intermediate-term data is peaking – Our overall view remains unchanged. Over the past week we’ve highlighted the relative performance shifts developing consistently with an intermediate-term development that should last a minimum of 6-8 weeks, potentially
2-3 months.• Expect a volatile trading range into the summer – Our expectation is that by that time our weekly momentum indicators should have unwound from their current overbought condition and broad sloppy trading range above support will develop. Our expectation is that the current pullback will be relatively shallow with a ‘healthy’ 33% to 50%
retracement of the March-May rally developing for most stocks into early-mid Q3.• 2-3 week directional shifts likely – This optimistic scenario would see stocks swing through 2-3 week directional shifts through that time. In the very near-term a short-term trading low will likely develop by mid next week given our daily momentum indicators are likely to be deeply oversold just after this Friday’s option expiry. By then many stocks should be near next support levels near 50-dma’s and suitably oversold to support a 1-3 week trading bounce.
• Wait for the technical evidence to improve – However, it is important to clearly separate expectations from the underlying technical evidence. A negative technical shift is currently in place consistent with an intermediate-term peak in equities and, while our expectations are outlined above, it will be important to wait for the technical evidence to improve to support a more aggressive pro-cyclical investment stance. We have outlined our expectations
specifically for those investors that argue they need to anticipate pending direction shifts. However we also believe our relative performance heat map will provide a timely indication of when a more bullish performance shift is developing.
