In early July, the broad market failed to make new lows even despite bad news. The CPI print came in at a 40-year high, followed by the producer price index surprising to the upside. This told the market that inflation was still an issue and would likely be into the near future. This was then followed by mixed banks earnings, as reports of a looming economic slowdown and run-away inflation was starting to show up in earnings.
Yet, the S&P 500 continued to trend up on this bad news, which is a pattern we typically see around meaningful shifts in trends. Once the market starts going up on bad news, it’s telling us that what is known is priced in. What followed was a swift move that caught many investors off guard. Due to having ample experience in weathering pullbacks, we built key positions in the month of May and June as we felt the prices were “good enough” based on our time horizon.
With that said, outside of building key positions, we have also been warning our readers for the past month to be cautious. We still do not have confirmation that the bear market is over and we will have better opportunities to accumulate if this confirmation starts to develop.
What we want to see to start building this case is: 1) We only have a 4-wave bounce off the June 16th low. We want to see this bounce make one more high, which would complete a 5 wave pattern; 2) Rates need to confirm a bottom; 3) The US dollar needs to confirm a top.
I believe that the most important of these three occurrences is the first one. Trend reversals tend to develop in 5-wave patterns. If we can get a confirmed 5-wave push off the June low, the odds will start favoring a bigger uptrend is developing over the long-term. However, because the bond market and USD is not lining up with this scenario, investors should be cautious and expect more volatility until they do.
In last week’s broad market webinar, we warned our readers that a pullback was imminent. We also laid out what levels need to hold in order to confirm a new uptrend is forming. We also showed that the bond market is simply not buying what the equity market is, and that the USD pushing to new highs along with equities. These markets are simply not aligned with the current uptrend in equities, and until they are, we will remain cautious.
The below video goes through the levels as well as possible scenarios we could see play out over the coming months...
- The Bull Case: we want to see a pullback into the 4165-4020 region. We then need to see the market hold this region, and then turn back up to make one more high. If this happens, we have a clean 5 wave push off the June low, and a important evidence that a new uptrend is developing into 2023. Since the last video, the S&P 500 pulled back just over 4% in three trading days, and is currently in our target zone. We need to see buyers push the market above SPX 4330 to confirm that final 5th wave. We should know in the next two weeks if the above scenario is in play.
- The Bear Case: if we fail to make a new high above SPX 4330, and instead turn back down below the 4020 region, what the market is telling us is that 2023 is likely setting up for another leg down in the current bear market. If this does happen, we will be looking for one more large push higher into the Fall before we prepare our portfolio for this outcome.
No matter what scenario plays out, we expect around a ~10% pullback in the coming weeks, which should be followed by one more large push above SPX 4400 before the next leg lower begins. Here is an updated chart with the two scenarios we are tracking (blue is the bull case and red is the bear case).
Supporting Markets - Rates, USD
These are the charts that we have been tracking weekly. They are also the primary culprits behind the downward pressure on equities. Runaway inflation has forced the bond market to sell bonds due to a fixed yield well below the current CPI prints. Bonds do well in deflationary environments and poorly in inflationary ones. As bonds go down, rates go up, forcing equities to reprice their future projections.
