A 3rd and what we'd consider the most unfortunate scenario can't be ruled out either. It would take the form of the market having a sideways to slight upwards bias with lots of chop where rallies are sold and dips are bought. It would be accompanied by low volume, low VIX and low momentum follow through.
We take stabs at building cases for each scenario daily. Below we've listed out evidence in support of each side:
Trend
- S&P 500 monthly chart and its 12-month MA. This simple long-term trend following tool remains bearish but is getting close to trading back above the MA.
- Testing the back side of the failed monthly uptrend from 2009 bottom.
- On shorter time frame a ton of overhead supply from the Feb-Mid August top.
- All 9 major sectors are above their 20-day MA, all but 1 are above 50-day, 4 out of 9 are above 200-day.
- XLY:XLP ratio continues to consolidate in uptrend. A break below would be bearish.
- Relief rally in emerging markets.: EEM, EFA, FXI. EEM has broken up above shorter-term down trendline but facing significant long term resistance.
- We continue to monitor the consolidation in the dollar and oil markets. A breakout in either direction will have ramifications for the global markets.
S&P Monthly & 12-Month MA
S&P Monthly Chart Below Long-Term Trendline
S&P Daily Chart - Key Test of Overhead Resistance
XLY:XLP
Emerging Markets (EEM)
VIX
- Has come back below the breakout level and has dropped like a stone.
- VIX term structure back in contango after spending a good month in or around backwardation.
Breadth
- Overbought on short-term and but not yet on intermediate term (% of stocks above 20 & 50 MAs)
- Stochastic overbought on major 4 domestic index's
- A/D line advancing with market but still in downtrend with overall market
- % of stocks above 40-day has gone from extreme oversold to overbought. Very similar to Oct. 2014 bottom.
Sentiment
- NAAIM Exposure index still remains light. This is bullish. Still plenty of money to put to work.
- Fear & Greed Index is Neutral
- Put/Call Ratio - Has backed off extreme readings and back in normal range
- Bearish sentiment remains elevated even after the current rally. This is contrarian and good for bull case.
Putting this all together gives us a better idea of how these scenarios might play out and provide for a better strategy going forward as we try to put the probabilities in our favor.
Right now, we're more inclined to think the market is likely to take out overhead resistance after working off the current short-term overbought levels. This bullish scenario could be propelled further by the best 3-month calendar timeframe in terms of historical seasonality on deck. Couple that with plenty of cash on the sidelines from active managers and an accommodative/dovish Fed and the stage may be set for a rally.
What will change our opinion is a negative market reaction to the upcoming rush of earnings announcements that's joined by an expansion of downside breadth.
