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The S&P 500 and Nasdaq Composite rallied again last week, increasing 1.4% and 1.6% and leading investor portfolios higher. This rally has pushed both indexes back above their 10-day moving averages to reclaim positive momentum. As noted last week, despite the recent pullback, the 50-day moving average still has a moderately positive slope and is still well above the 200-day moving average on the S&P 500.

I see this as a positive development. The bulls historically have had a much easier time clawing back gains when corrections occur below a rising 50-day moving average than one with a negative slope that can often provide strong resistance (such as March, May, and June of 2022).

That said, the bulls are still not out of the woods yet. While they’ve done a good job playing defense to ensure a higher low above 3765, this recent strength has not yet translated to an improvement for the big picture, with both indexes remaining below their 20-month moving averages.

A strong confirmation of this breadth thrust would be a monthly close back above the 20-month moving average for the S&P 500 (4220), pushing the S&P 500 back into a bullish position. The 20-month moving average is shown below (teal line), and as we can see, rallies above this level have ended cyclical bear markets historically (January 2016, January 2019, April 2020).

(Source: TC2000.com)

Valuation & Sentiment

Last week, we saw a tick up in the Shiller PE Ratio to 29 following the market’s rally, which is well below the reading of 40.0 at the start of this cyclical bear market (January 2022). However, still well above where bear markets have ended historically, which is at or below 22 on the Shiller PE Ratio. This doesn’t mean that the market must decline 25% from current levels in order for this bear market to end.

For one, this could be an outlier, and secondly, the more time this correction takes, the more earnings will play catch-up and lower the Shiller PE Ratio. That said, with valuations not yet in buy territory, I continue to remain neutral on the market from a valuation standpoint, forcing me to maintain a cash position of at least 25-30%.

(Source: Multpl.com, Author’s Chart)

As far as sentiment goes, we have seen an increase in pessimism recently. While it’s nowhere near December 2022 and January 2023 levels, it has improved from moderate optimism in February 2023 to signs of some fear over the past two weeks. I see this as a positive sign, and it’s evidenced by the put/call ratio, which saw one significant spike and several other elevated readings.

Obviously, this recent pessimism is justified given the fear of more bank failures. That said, the steps taken thus far suggest a low likelihood of systemic risk with bank runs. This appears to have calmed the market, even if it does mean the rate hike trajectory could be less steep than previously anticipated. In addition, I see the 25 basis point hike as positive, given that a rate cut or pause could have been a negative development for ensuring inflation readings are reeled in successfully.

(Source: CBOE Data, Author’s Chart)

To summarize, both valuations and sentiment remain on neutral readings currently, so there is no major edge here for either the bulls or bears. As I’ve discussed in past updates, the bulls do have one indicator massively in their favor, and this is the breadth thrust that was recorded on January 12th, 2023. This signal has a strong track record with positive returns 88% of the time over the next 12 months, a 16% average 12-month forward return, and no undercuts of a previous major low (3500 in this case) over the next 6 months.

Now, this indicator could fail and there are no guarantees in the market, even with a near flawless track record this signal has. However, assuming it does play out, the S&P 500 is likely to trade up towards 4400 by late July and 4600 by year-end, pointing to more than 15% upside from current levels which certainly justifies maintaining long exposure. For those interested, previous readings occurred on May 13th, 2019 and June 3rd, 2020.

Action Plan

Heading into this week, the S&P 500 is above the midpoint of its strong support/resistance range (3500 vs. 4315) at 3970 and just below the midpoint of its range using short-term support at 3765 – 4315 resistance, resulting in a slightly positive reward/risk setup for the market short term. Given that the 90% downside volume day, which often occurs post-breadth thrust, is out of the way (occurred on March 9th) and we see strong short-term and medium-term returns with limited drawdowns following these signals, I would be elated if we saw further weakness in the markets, and I have an order to add to my position in the S&P 500 near 3780 (376.00 on the SPY ETF).

(Source: TC2000.com)

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Adam Mesh

Adam Mesh is the founder and CEO of WealthPop.com. Adam has extensive experience in the stock market, as well as being a options trading coach for many years. Our mission is to empower the average, everyday individual to become a better investor and trader.

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