The last few weeks have been sensational for risk assets, with the S&P 500 and the Nasdaq 100 breaking new all-time highs. Remarkably, the Dow Jones Industrial Average even touched 40,000 for the first time in market history. With the market on such a high, one critical question remains: Is this rise sustainable? Let’s explore further.
Before we dive into the charts, let me clarify a bit about my approach. As a technical analyst, I spend countless hours daily pouring over hundreds, if not thousands, of charts. However, my decision-making is not solely technical. I also consider fundamental factors, like macroeconomic data, Federal Reserve actions, inflation, and interest rates. These elements collectively impact the stocks and ETFs I monitor.
About a month ago, in mid-April, we were contemplating market breakdowns. The S&P had briefly dropped below its 50-day moving average, suggesting a target near 4800. But since that point, stable inflation data, a weakening dollar, and declining long-term interest rates have turned things around, shining a favorable light on equities.
When markets hit new highs, setting arbitrary price targets can often be limiting. Instead, follow the trend. From my experience with growth-oriented money managers, trend-following is more effective. Selling at an arbitrary price can cause missed opportunities if the trend continues upward. Focus on riding the trend and exiting only when it shows signs of faltering.
Have you ever sold a stock up 20%, then sit on the sidelines as it went up another 200%? Then you know why trend-following can be such a profitable strategy!
According to Charles Dow’s original work, an uptrend is formed by higher highs and higher lows. As long as we stay above 4950-5000 on the S&P, the uptrend by definition would still be in place.
I've compiled a chart combining S&P 500 analysis with two other pivotal metrics: the high yield bond market and the VIX (Volatility Index). The chart layers the S&P 500 on a closing basis, an inverted VIX for clarity, and the High Yield Index Option-Adjusted Spread (OAS) from Bank of America.
The High Yield Index OAS measures the spread between risky corporate bonds and Treasury bonds. Currently, the spread is around 3.1%, its narrowest in two years, indicating a low-risk environment as per bond investors.
An inverted VIX makes it easier to track market stress. Normally, a low VIX indicates healthy market conditions. Conversely, a spike in VIX signals increased investor anxiety. Inverting the VIX aligns it with S&P movements, simplifying interpretation. The VIX remains at extremely low levels.
So, why is this chart crucial now? It helps confirm the bullish trend. Tightening spreads and low volatility suggest favorable conditions for equities.
However, certain signs could indicate a shift. If credit spreads widen or volatility rises, it signals growing investor anxiety. Most importantly, if the S&P dips below 5000, breaking the uptrend, it would suggest a potential market shift.
In summary, the market remains bullish as of mid-May. Keep an eye on the spread, volatility, and the S&P's performance for any signs of change. Should these metrics shift, reconsidering your portfolio allocation may be wise.
RR#6,
Dave
Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.
The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.