Stock Market Internals are Weakening by the Day
As in my current piece masking the outlook for the , I stay pretty cautious towards equities over the coming months.
Since laying out my thesis on how we could also be nearing a market prime, a lot of the key indicators and metrics to which I got here to such a conclusion have solely worsened. Some markedly so.
Indeed, at the centre of the indicators and measures of market “health” to which I communicate are the numerous measure of market internals, which as we will see, have now change into wholly unsupportive of this inventory market rally.
Beginning with my most well-liked measures of short-term market breadth, as we are able to see beneath, this newest excessive in the S&P 500 has been accompanied by decrease highs in the proportion of shares buying and selling above their 20-day shifting averages, the eight-day rate-of-change in the S&P 500’s advance/decline line in addition to the McCellan Oscillator.
Not solely are we seeing bearish divergences in these short-term measures of market breadth, however we’re seeing comparable divergences in a few of the longer-term measures I monitor, as proven beneath.
When actionable indicators are triggered throughout a number of time frames (be they bullish or bearish), it’s value taking word. As it stands, inventory market breadth throughout all time frames is woeful.
What now we have additionally seen these previous weeks is a lot of long-term warning indicators triggering amongst the Nasdaq and NYSE’s constituents in the type of a number of Hindenburg Omen and Titanic Syndrome promote indicators. These eccentrically named indicators are successfully simply warning indicators that use numerous measures of market breadth as inputs, and after we see a lot of such measures set off in a brief time period (as now we have seen on the Nasdaq of late), it’s typically related to value motion being near some type of market prime.
Indeed, per the work of SentimenTrader, “during the past three weeks, these two indicators have triggered a combined eight signals. That’s the most since December 2021. We can see from the chart below that when eight or more signals were triggered, the ‘s annualised return was a horrid -29.3%.”
Nasdaq Composite Index Chart
Importantly, poor market breadth just isn’t the solely measure of market internals which traders needs to be cautious of at current. Both my Pro-Cyclical Index and Risk Appetites Index have additionally diverged notably from the S&P 500 in current weeks. What this implies is the current highs in the broad index aren’t being confirmed by the outperformance of pro-cyclical and economically delicate shares, neither is it being confirmed by way of the outperformance of high-beta and risk-on property that will usually accompany a sustainable market rally.
Daily Stock Market Internals
This is true each on a each day and weekly foundation. The earlier instances my Risk-Appetites Index diverged from the S&P 500 to such a level was in late 2018, early 2020 and late 2021. Each occasion preceded some kind of market correction.
Weekly Stock Market Internals
However, it have to be stated that deteriorating market internals aren’t a assure of any type of market correction, and even pull-back for that matter. Market internals can self-correct by way of cyclical outperformance and broad underlying participation, one thing now we have really seen to a minor diploma over the previous couple of days.
But, after we view the poor market internals in the context of inventory market positioning, it does make it harder to argue for a continuation of this rally. As we are able to see beneath, asset managers and systematic volatility funds are at the moment lengthy this market to an excessive diploma (one which usually portends poor subsequent returns), whereas survey positioning measures comparable to the AAII Bull-Bear unfold are additionally near ranges consultant of maximum euphoria. Of course, the exception right here is hedge funds, who’re one supply of capital who’ve scope so as to add extra lengthy fairness publicity.
Asset Manager & Hedge Fund Positioning
But in mixture, positioning is reaching a stage that’s usually related to some type of market prime. Case and level are pattern following CTA managers, who in keeping with Goldman Sachs, are lengthy the market to such a level they’ve little upside shopping for to do at present ranges, however a complete lot of promoting ought to shares retreat.
Source: Goldman Sachs
One essential issue that has been a major driver of the current energy in shares has been the rise in web liquidity (blue line beneath, proxied by way of industrial financial institution reserve balances). Despite the Fed trying to cut back its stability sheet and shrink the stage of reserves in the system by way of QT, this has been greater than offset for a lot of 2023 on account of the Treasury issuing an elevated proportion of their debt in the type of shorter-dated Treasury Bills, versus longer-dated Treasury Coupons. This has allowed cash market funds (who’re flush with money) to maneuver their capital out of the Fed’s Reverse Repo Facility (RRP, which is successfully cash that’s exterior of the monetary system) and purchase the newly issued Treasury Bills. And, as long as the Treasury has been drawing down its account at the Fed funded from its debt issuance, which it has been doing, these monies of cash market funds successfully discover their approach out of the RRP and onto industrial financial institution balances sheets, thus rising the stage of reserves in the system, and rising web liquidity.
This course of has been supportive of danger property for a lot of 2023 as industrial financial institution reserves have been rising all through the previous yr. But, that is additionally a course of that can’t final eternally. Indeed, not solely has the RRP stability (purple line above) fallen from $2.5t to
As it stands, based mostly on the newest Quarterly Refunding Announcement from the Treasury, the short-term issuance outlook just isn’t essentially bearish as the Treasury solely marginally decreased its deliberate proportion of Bill issuance for the coming quarter. But, as long as the Fed is endeavor QT, sooner or later this yr this dynamic will matter given the depleting stability of the RRP.
Moving on to seasonality, that is one other essential dynamic I’ve mentioned a lot in current in instances given the rising affect of delta heading flows surrounding the month-to-month choices expiration on the again of report structured product issuance. The subsequent window of vulnerability is about to open following February’s choices expiration on the sixteenth of this month. As we are able to see beneath, that is usually a interval that’s lower than favorable for the S&P 500, notably provided that it additionally coincides with below-average company buybacks.
S&P 500 Index Seasonality
From a technical perspective, issues are additionally trying a little bit precarious. The S&P 500 appears to be like to be forming an ascending wedge sample, one that’s usually thought-about a reversal technical sample, and is doing so amidst a divergence in the RSI in addition to a just lately triggered 9-13-9 DeMark sequential promote sign.
Another space of the market that appears prefer it might proceed to exert stress on shares are yields. As we are able to see beneath, the yield stays nicely supported above the 3.8% space, and stays above its 50 and 200-day shifting common. Unless this stage is damaged to the draw back (one thing which I stay skeptical will happen for the time being), stress will mount on the present rally in shares.
Indeed, if we examine the inverse relationship between yields and the yield-sensitive Nasdaq, the previous couple of months has seen the Nasdaq rally in the face of rising yields in an identical method to what occurred throughout the latter levels rally all through the first half of 2023.
One issue that might exert additional upside stress on yields themselves is a bounce in headline inflation. While I count on core CPI to pattern decrease all through a lot of 2024, as I detailed right here, there stays a good likelihood we’re near a backside in headline CPI, with items inflation trying prefer it might reaccelerate over the coming quarter or two. This is a dynamic my inflation-leading indicator has been signaling for just a few months now.
Inflation Indicator vs CPI
Given that the market is 1) priced to perfection from a development and inflation standpoint, and a couple of) pricing in a a lot simpler Fed all through 2024, issues might get ugly if the tender touchdown that consensus now expects doesn’t eventuate, or even when the downtrend in inflation is close to its crescendo.
Whether we do see a pull-back of some sort in the coming month or two or whether or not we see sideways to up value motion stays to be seen. But, given how excessive positioning has change into and the poor state of market internals, the current doesn’t seem like a very good time to be shopping for the S&P 500. At the very least we should always count on to see a rotation out of the dominant shares inside the Nasdaq and S&P 500 and into a few of the extra cyclically delicate names.