Overview and Bottom Line
A historical advance followed a historical decline as the S&P 500 got close to its late February levels and the scene of the crime. That crime was the breakdown that signaled the beginning of a bear market. Even though the surge over the last six weeks is also record breaking, it has yet to break the bear’s back. Today we will review the weight of the evidence and put this bounce into perspective.
Despite a massive advance the last six weeks, the bulk of the evidence indicates that we are still in a bear market environment. The advance off the March low, while impressive on its own, still pales in comparison to the prior decline. The S&P 500 SPDR retraced around 61.8% of this decline and the Russell 2000 ETF retraced just over 50%. Such retracements are still normal for counter-trend bounces.
Consider the following. SPY, the S&P 500 EW ETF, the S&P MidCap 400 SPDR, the S&P SmallCap 600 SPDR and the Russell 2000 ETF are all below their falling 200-day SMAs. Nine of the eleven sector SPDRs are also below their 200-day SMAs. The Nasdaq 100 ETF, Technology SPDR and Healthcare SPDR are above their 200-day SMAs and leading, but they cannot do it alone. Moreover, not one index or sector recorded a 52-week high this month.
At best, the market environment is "not" bullish and we could be entering a trading range. At worst, the market environment is bearish and the counter-trend bounce is close to reversing. Either way, risk is above average right now and bad things are more likely to happen when risk is above average.
SPY Stalls at Top of Danger Zone
The next chart shows SPY over the last four years and a big broadening formation since January 2018. The widening swings since January 2018 reflect a trend-less and out of control market. In the last two years, SPY broke out to all time highs twice and broke to 52-week lows twice. The ETF is currently just above the mid point of its huge range, which I would consider no-man’s land.
The next chart focuses on the February-March breakdown and the March-April counter-trend bounce. You know the drill. SPY hit the 61.8% retracement and stalled just below the falling 200-day SMA for two days. This is a dangerous spot. With today’s weak open, SPY is basically unchanged since April 14th, which is when it first closed in the danger zone. RSI has been above 50 for the last 17 days. Watch for a break here to signal a downturn in momentum.
Uptrends versus Downtrends
Bullish signals are not always the mirror image of bearish signals. It seems that we could just reverse the bullish signals and have a robust strategy for short positions. This does not always work because uptrends are characteristically different than downtrends. Uptrends often start with a massive thrust and then methodically work their way higher with lower volatility. Downtrends are more chaotic with sharp counter-trend bounces and higher volatility. It is often said that the market takes the stairs higher and the elevator down. It is much easier to trade mean-reversion bounces in an uptrend than mean-reversion declines in a downtrend.
One New Signal in Index Breadth Model
There was one new signal as the 10-day EMA of S&P 500 AD Percent ($SPXADP) surged above 30% this week. Nevertheless, six of nine signals remain bearish and so does the model.
Small-caps and mid-caps led the market surge in early April as both triggered bullish breadth thrusts. They also led the surge in late April as the 10-day EMA of Advance-Decline Percent exceeded 39%. Also note that S&P 400 %Above 20-day EMA (!GT20MID) hit 98% and S&P 600 %Above 20-day EMA (!GT20SML) hit 96.3% on Wednesday. These are the highest readings in over 20 years. Crazy stuff, but still within the confines of a bearish signal for the Index Breadth Model.
Smattering of New Highs
So, the S&P 500 SPDR was up 31.5% as of Wednesday, while the S&P MidCap 400 SPDR was up 40.11% and the S&P SmallCap 600 SPDR was up 35.17%. Despite these massive moves, all three are still below their falling 200-day SMAs and there were just a smattering of new highs. Instead of the High-Low Percent indicators, I am showing the high-low pairs for each index. At least 10% of the components are required to record new highs to support a bull market and new highs fell woefully short this week. New highs in $SPX peaked on 16-Apr at 14, new highs in $MID hit 15 on Monday and new highs in $SML hit 9 on Monday. These are not bull market numbers.
The next chart shows that the percentage of stocks above the 200-day EMA did not exceed 40% for the S&P 500. Despite market leading advances, the indicator did not exceed 30% for the S&P MidCap 400 and S&P SmallCap 600. The moves below 40% triggered the bearish signals at the end of February and they have not even gotten close to 50%.
The next chart shows the Index Breadth Model signals over the last five years.
Click here for an article and video explaining the indicators, signals and methodology used in the Index Breadth Model. This article also includes the signals of the last five years.
%Above 20-day EMA in Danger Zone
The chart below shows the %Above 200-day EMA, %Above 50-day EMA and %Above 20-day EMA for the S&P 500. The first two indicators are used for trend following, the latter is used for mean-reversion. %Above 200-day is bearish when it crosses below 40% because it means the clear majority of stocks are below their 200-day EMAs. The %Above 50-day EMA is bearish when it crosses below 20% because it represents a momentous shift in the number of medium-term downtrends.
When the first two indicators are bearish, the third is used to identify short-term overbought situations for mean-reversion. The bigger trend is down, the trend mean is lower and a reversion to that mean is expected. %Above 20-day EMA moved above 80% three times since April 8th as the S&P 500 extended its short-term uptrend. The overbought signals worked good in 2018 (blue ovals), but this advance had a little more juice. Nevertheless, the bigger trend is down and I still view the 80% threshold as a danger zone for this mean-reversion indicator.
Close, but No Cigar
The next chart shows the %Above 50-day EMA for the S&P 500, S&P MidCap 400 and S&P SmallCap 600. A bullish breadth thrust triggers with a move above 80% and a bearish thrust with a move below 20%. The group turns net bullish/bearish when two of the three signal. All three triggered bearish at the end of February and surged above 70% on Wednesday. They fell back on Thursday and fell short of triggering a bullish breadth thrust.
Sector Breadth Model Turns Mixed
Unsurprisingly, there were breadth thrusts in several sectors this week. With more bullish signals, the sector breadth model is mixed, very mixed. The sum of the weighted signals is net bullish, but seven of eleven sectors are net bearish and 17 of 33 signals are bearish. Technology, Healthcare, and Communication Services are net bullish, while Finance, Consumer Discretionary and Industrials are net bearish. This is basically a split in the big six sectors.
The higher weightings in Technology, Healthcare and Communication Services turned the weighted sum positive. For example, Technology accounts for 25.59% of the S&P 500 and two of the three signals are bullish. Thus, 25.59% multiplied by +2/3 is +17.09%. Consumer Discretionary accounts for 10.33% and two of the three signals are bearish. Thus, 10.33% multiplied by -2/3 is -6.89%.
I do not have a signal tracker for the Sector Breadth Model, as I do for the Index Breadth Model. However, we can clearly see that the vast majority of long-term indicators are on bearish signals. Seven of the eleven High-Low Percent and %Above 200-day EMA indicators are bearish. These are longer-term indicators and it takes more than just a strong counter-trend bounce to trigger bullish signals.
XLK Triggers Bullish. Is this the Top?
Late signals and whipsaws are part of trend following, as are a few good trends. The idea is that a few good trends will pay for the whipsaws. Hardcore trend followers will tell you that you cannot predict which signals will result in whipsaws and which will lead to big trends. However, I will go on a limb and suggest that the bullish signal in XLK will lead to a whipsaw.
The chart below shows the 10-day EMA of Tech AD Percent ($XLKADP) moving above 30% and Tech %Above 200-day EMA (!GT200XLK) moving above 60% this week. Thus, two of the three indicators triggered bullish and this reverses the bearish signal from February 28th. Never mind that XLK High-Low% ($XLKHLP) did not exceed 6% this week.
So why would I suggest a whipsaw? First, the broad market environment remains bearish at worst and not bullish at best. Second, the advance retraced around 2/3 of the prior decline and this is still normal for a counter-trend bounce. Third, this looks like a counter-trend bounce (subjective rising wedge/channel).
Yield Spreads and Fed Balance Sheet
Investment grade bond spreads fell sharply from March 20th until April 14th (red arrows) and then stabilized the last two weeks. The blue lines mark the pre-crisis highs and these spreads remain above these highs. Fed intervention brought these spreads back to manageable levels, but they remain elevated, especially BBB bonds, which are the lowest rated of the investment grade bonds.
The next chart shows the junk bond spreads also falling sharply from March 20th until April 14th. These spreads also remain well above pre-crisis highs and even ticked up over the last two weeks. Junk bonds are the most vulnerable and most sensitive to the economy. As such, they act more like stocks than Treasury bonds. Perhaps the Fed will intervene here, but an uptick in these spreads would be negative for stocks.
The Fed balance sheet also expanded again this week, but this week’s $83 billion increase was the smallest since early March (middle window). The top window shows total assets increasing from the $4.1 trillion area to the $6.6 trillion area in less than two months. Gulp.
As noted before, monetary policy can prevent a meltdown in the credit markets (financial crisis) and fiscal policy can lessen the pain of an economic contraction. Together, these two can put a floor on stocks and bonds, but they do not remove the ceiling. Moreover, monetary and fiscal stimulus were ramping up in October 2008 and the S&P 500 did not bottom until March 2009.