US Equity Market Outlook
July 2, 2017
- Macro conditions limit downside
- Advance/decline line confirms market levels…for now
- Underlying supply/demand configuration suggests internals are weakening
- Sentiment likely needs to return to depressed levels for demand to return to the market
Heading into the November 2016 US presidential election, a positive divergence in the S&P 500 and US equity market advance/decline line pointed toward oncoming new ATHs for the Index. Following the election, a decisive spike in underlying market demand suggested the market rallying was sustainable and likely to remain in place for months.
In early 2017 I posited that the trading year could set up to be a picture perfect “sell in May” type of a year: While underlying demand suggested a 2013-style rip, elevated valuations and an increasingly aggressive Fed would likely cap the rally, if not ignite a summer/fall correction. Broadly, I believe this set-up is beginning to play out; but more market volatility is required to confirm.
Without a choppy topping process in place, it is difficult to predict a 2011- or 2015-style decline; but at minimum – based on deterioration in underlying market health and complacent market sentiment – the market is currently due for its first 5% correction in some time. This dip should be bought aggressively, and the subsequent rally watched closely.
Macro. The most important chart in global finance continues to be the YOY percentage delta in US Jobless Claims – as the US economy has never entered a recession without it breaching +20%, and global equity markets have never entered a large-scale bear market without the US economy entering a recession. US Jobless Claims continue to fall YOY, indicting firm support to global and US equity markets.
BB high yield spreads confirm robust economic conditions. Though with an aggressive Fed and a likely uptick in inflation, spreads could be considered too low.
A/D Line. The US equity market’s advance/decline line (ADL) continues to confirm the cyclical bull market that has been in place since February 2016. This is bullish. But the ADL must be included in a broad set of supply/demand indicators, as it can be late to confirm market tops bottoms. (IMO, it is most useful for divergence analysis, as in late 2016.)
Breadth. The percent of S&P 500 and NYSE stocks above their 200dma have diverged materially, to the negative, from the indices. But most critically, the percent of SPX stocks with 50dma > 200dma has decisively turned down. Lastly, it is also worth highlighting the recent price v. breadth action in the DAX as an example of a negative breadth divergence resolving itself to the downside.
Sentiment. Confirming the deterioration in market breadth, the choppy-yet-elevated action of the S&P 500 DSI sentiment gauge suggests a “shakeout” is necessary to bring decisive demand back into the market.
Catalysts. Per usual, it is very difficult to predict the catalyst for a market correction, as the market will simply manufacture an excuse to punish “offsides” positioning. But if forced to guess, based on the market’s reaction to the delayed Senate healthcare vote I would say that market participants are looking for confirmation of policy progress to justify positioning, and thus a lack of progress could ignite a correction.
But that thinking seems vacuous. Market breadth is pointing to something larger than a failed healthcare vote; so even if the bill passes, a more serious-yet-unknown catalyst is likely coming down the pike.