Stocks: More New Highs, but a Correction May Be Looming
S&P 500 keeps reaching new record highs, but isn’t it forming a topping pattern?
Monday’s trading session wasn’t a game-changer, with the S&P 500 index gaining 0.28% after reaching a new record high of 5,666.94. The market essentially kept extending its short-term consolidation following last Wednesday’s rally, Thursday’s CPI release, and Friday’s PPI release. This morning, the S&P 500 index is likely to open 0.1% higher, as indicated by futures contracts. The sentiment remained slightly positive after the earnings releases from BAC, MS, and UNH.
On Friday, I wrote “Thursday’s trading session brought declines for the stock market (…) It was a typical sell-the-news price action following lower-than-expected consumer inflation data. But was that a change of trend or just a quick downward correction? For now, it looks like a correction, but it seems that bulls will be in a defensive stance for a while.”
Last Tuesday I decided to open a speculative short position. In my opinion, the position is still justified.
Investor sentiment has increased significantly last week, as indicated by the AAII Investor Sentiment Survey on Wednesday, which showed that 49.2% of individual investors are bullish, while only 21.7% of them are bearish.
As I mentioned in my stock price forecast for July, “While more advances remain likely, the likelihood of a deeper downward correction also rises. Overall, there have been no confirmed negative signals so far, but the May gain of 4.8% and June gain of 3.5% suggest a more cautionary approach for July (…) The market will be waiting for the quarterly earnings season in the second half of the month. Plus, there will be a series of economic data, including the CPI release on July 11, the Advance GDP number on July 25, and the FOMC Rate Decision on July 31.”
The S&P 500 index continues trading near its record high, as we can see on the daily chart.
Nasdaq 100 Remains Relatively Weaker
The technology-focused Nasdaq 100 index closed 0.27% higher yesterday, remaining well below its record high of 20,690.97 that was reached on Wednesday.
Last Thursday, I concluded that “There are short-term overbought conditions, and the market is likely to top at some point.” This proved accurate with the Nasdaq 100 reversing sharply from its new record high. This morning, the Nasdaq 100 is likely to open 0.2% higher, extending a consolidation ahead of the important big tech earnings releases next week.
VIX: Slightly Higher, Closing Above 13
The VIX index, also known as the fear gauge, is derived from option prices. Recently, it has been hovering around the 12 level, which historically is relatively low, indicating low fear in the market. Yesterday, it closed slightly above the 13 level, indicating a little more fear in the market.
Historically, a dropping VIX indicates less fear in the market, and rising VIX accompanies stock market downturns. However, the lower the VIX, the higher the probability of the market’s downward reversal.
Futures Contract Is Still Close to 5,700
Let’s take a look at the hourly chart of the S&P 500 futures contract. Wednesday’s CPI release led to a pullback from a new record high above the 5,700 level, and on Friday, it traded as low as 5,621. Yesterday though, the market reached a new record of around 5,719, before pulling back and closing below 5,700. It still looks like a short-term consolidation, and possibly, a topping pattern.
Conclusion
This morning, the S&P 500 is likely to open slightly higher following yesterday’s intraday pullback from a new record high. Will the uptrend continue? Earnings releases are generally better than expected, however, they are also met with ‘sell-the-news’ price action. The index remains very close to new records, but the risk of a more pronounced downward correction is increasing.
I opened a speculative short position in the S&P 500 futures contract last Tuesday.
Quoting my stock price forecast for July, “Investors continue pricing in the Fed’s monetary policy easing that is supposed to happen this year. Hence, a medium-term downward reversal still seems a less likely scenario. However, the recent record-breaking rally may be a cause for some short-term concern as a downward correction may be coming.”
For now, my short-term outlook remains bearish.
I think that short positions are justified from the risk/reward point of view.
Here’s the breakdown:
- The S&P 500 index may be marking a topping pattern before some downward correction.
- Investors are waiting for the coming quarterly earnings season.
- In my opinion, the short-term outlook is bearish.
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Thank you.
Paul Rejczak,
Stock Trading Strategist