SPX Signals Say Wall Street's Caution Could Be Overblown

 “The percentage SPX components that are higher using a three-month lookback has increased to 40% from an early-May trough of 25%...The contrarian takeaway is at a time the consensus is buying into the potential bearish implications of only a few stocks doing the heavy lifting, we could be on the verge of a broad-based rally that drives the SPX higher, even if mega-cap stocks lose their leadership.”

              -Monday Morning Outlook, June 5, 2023

“Market breadth has improved notably, with multiple sectors outside of technology exhibiting stronger relative strength trends… there’s still a ‘high probability’ of a pullback ahead as we move beyond June…the rally in equities faces a fresh threat over the next few weeks with the world’s biggest money managers set to unload as much as $150 billion of stocks. JPMorgan Chase & Co. projects real-money portfolios will tilt back in favor of bonds to meet allocation targets, in the largest rebalancing flows to the asset class since the fourth quarter of 2021.“

              - Bloomberg, June 16, 2023

“The artificial intelligence-fueled rally also ran right over continuing calls from some corners that a recession may soon appear, perhaps a reflection on a year of perpetually unrealized downturn predictions… Still, as Powell and others warned, the US economy doesn’t stop on a dime, and the central bank’s tightening measures may have yet to be fully felt.”

              - Bloomberg, June 16, 2023

As you can see from the excerpts above, there was a cautious outlook for the stock market ,from a technical perspective, ahead of this month’s advance and last week’s explosive rally.

Breadth concerns were running rampant as we entered June, even though a breadth measure that I was observing was showing significant improvement. With some technicians caught flat-footed, or perhaps on the wrong side of the market, there is evidence that there are still money managers and advisers that are throwing caution into the wind -- whether that is Fed Chairman Powell warning that interest rate increases may not have taken full effect, or worries from major brokerage strategists, who have been cautioning us since early April about a correction being imminent. Instead, the S&P 500 Index (SPX-4,409.59) has rallied nearly 8% from the April levels.

“Wells Fargo’s Scott Wren says he is fading the stock market rally”

          -CNBC, June 13, 2023

Notably, the same Wall Street strategists that were expressing considerable caution toward equities in April and May have not capitulated. For example, J.P. Morgan, Wells Fargo, Goldman Sachs and Citigroup issued cautionary notes in April and May and many are sticking to their guns. For example:

• Early last week, J.P. Morgan reiterated its cautious views from early April, suggesting there is a disconnect with the bond market. Late last week, it advised of a re-balancing that could knock stocks for a 5% loss.
• Also, early last week, Morgan Stanley advised its clients that the bear market is not over due to an apparent disconnect with stocks and their earnings forecast for 2023.
• Bank of America strategists weighed in late last week, warning investors that we are not at the start of a rally and risk of a “big collapse” coming
• Goldman Sachs was the least cautious, as its strategists revised their SPX year-end target from 4,000 in early May to the present view of 4,500. Note they raised the year-end expectation after the SPX had rallied, and that they expect little upside based on Friday’s close.

I have seen comments from money managers that essentially replicate what you see above, suggesting that there could be a plethora of potential investors that have missed this rally and, as such, could represent future buying power.

For what it is worth, only one strategist among 17 tracked by MarketWatch sees the SPX higher than it is now at year-end. A couple charts that crossed my desk last week reflect the sentiment discussed above.

Note that short interest on SPX components increased by 8% from its late-January trough into the June 1 short interest report. Even more interesting is that short interest on Nasdaq-100 Index stocks is at its highest level since 2017, and is up 16% from its recent end of February 2023 trough. I suspect short covering could have occurred last week and will be reflected in the mid-June report that will be made available in late June. Suffice to say that shorts are feeling pain and could represent more fuel in the weeks or months ahead.

As I have said in previous market commentaries, rather than get into game of what the Fed will do next or whether or not a recession is ahead, allow the market to guide you in your investment decisions.

Indeed, pullbacks or hesitations from present overbought conditions is certainly a possibility, but so too are continued rallies even it its overbought stage. I don’t see a need to disturb your bullish positions unless and until the SPX declines below the 4,160 level, so use pullbacks as buying opportunities for now. 

There are two potential support levels above the key 4,160 level to put on your radar if a pullback occurs in the days or weeks ahead:

1. 4,375 - the March 2022 breakout level above a trendline that connected lower highs from January through February 2022, and
2. The 4,290- 4,300 area - roughly 20% above the 2022 closing low and site of a trendline connecting higher highs since March

Todd Salamone is the Senior V.P. of Research at Schaeffer's Investment Research.

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