While equities have shown considerable strength in recent months, there are indicators suggesting that 2024 may not be as optimistic as one might think. I continue to maintain confidence for this year and have been bullish for the last six to seven months. However, you have to acknowledge the possibility of a shift in market dynamics, which could occur at any point. As responsible risk-takers, whether in financial markets or any other industry, it is essential to anticipate and be prepared for various outcomes.
We engage in speculation because we believe we can surpass broad market performance. The means by which we achieve this outperformance is a personal choice. However, there's a commonality among successful individuals in this pursuit. Contrary to a common misconception, speculation is not about predicting or just gambling, which is why I prefer not to use the term 'speculator.' A proficient market participant sees themselves as a market reactor or responder. We anticipate, react, and respond. We diligently prepare for all potential outcomes that could impact our decisions and positions. While it's easy to formulate a theory on why stocks might rise, the crucial question is: What is your plan if that scenario doesn't unfold? This is the current situation we face, and the essence of this post is to prompt consideration. You might be enjoying success now as a trader or investor, but are you ready for a sudden downturn?
While the equity market may initially appear promising, a closer examination reveals some challenges. We extensively discussed the correlation between equities and the US Dollar, which has recently deviated over the past two months. The stock market has not adhered to the narrative presented by the US Dollar and the US 10-year yield. Although no correlation is flawless, one of these assets will likely need to adjust first. Considering the market internals discussed below, it seems plausible that the stock market may need to relinquish its gains for a few weeks.
First, in a bullish stock market setting, it is essential for the expansion of new 52-week highs to confirm real bullish momentum. A reduction in the number of new highs indicates a possible end to the bullish trend, as depicted in the accompanying chart below.
Another related indicator is the percentage of stocks above their 200-day moving average, which also indicates a divergence. This breadth indicator is highly useful for analyzing significant market tops and bottoms. A multitude of stocks below their 200-day average suggests anything but a bullish scenario...
Another challenge confronting equity markets is evident in the "risk on/risk off indicator," specifically the discretionary versus staples ratio. Another divergence is apparent in this regard. The implications of these indicators cannot be ignored. Refer to the chart below.
Another indicator that fails to affirm the bullish sentiment is the S&P 500 retail sector. Given that consumer spending contributes to around two-thirds of the US economy, it is an important factor to consider. While the stock market doesn't always mirror the economy, it tends to react significantly to abrupt shifts in the business cycle. The performance of retail stocks holds substantial implications for economic health; increased consumer spending generally bodes well. The relative performance against the S&P 500 is particularly insightful. Retail leadership plays a crucial role in shaping market speculators' sentiments about the economy and the stock market. When a divergence arises, it warrants attention. The chart below illustrates such a scenario, where the relative performance fails to confirm the new highs achieved by retail stocks. During the onset of robust bull markets, it is essential for retail stocks to contribute positively, which is currently not the case. Refer to the chart below.
These are just a couple of market indicators hinting at some instability in the backdrop, and it's crucial for us to remain mindful of them. Especially when they're all giving us the same similar message. It doesn't necessarily spell doom for the overall equity market, but if you're heavily invested in stocks at the moment, this could be an opportune time to reduce exposure and sell into the recent strength we've observed. Regardless of the outcome, it's essential to be prepared for various potential scenarios. How do you perceive the current market environment? Let us know!