Last week, we noted that the market did flip the previous “sell signal,” with stocks topping 5600 for the first time. However, that move also pushed the market back into extremely overbought territory, and the deviation from the 50-DMA is quite significant.

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As noted:

“Such suggests that, as we saw in late May and June, the market will either consolidate or correct back to the 20-DMA. If the bulls can hold that level again, as they have, the market could continue to push higher. Such is possible given the current exuberance surrounding the Fed cutting rates. However, if the 20-DMA fails, as in early April, the 50-DMA becomes the next logical support, with the 100-DMA close behind. Such would encompass another 3-5% correction.“

On Friday, the market broke the 20-DMA and flipped the MACD indicator back onto a short-term “sell signal.” While we will likely see a rally early next week, a failure to close above the 20-DMA may suggest a further correction to the 50-DMA. A further correction is possible with the market oversold and triggering a fresh sell signal. Those triggers led us to take profits out of several positions this past week to hedge against a further decline. We will raise cash levels further if technical deterioration continues.

While there has been some angst this week over the pullback, this remains an ordinary pullback in a bullish market trend. As shown, volatility remains suppressed, suggesting no real market panic.

While expected for some time, this correction process could accelerate into a more significant decline. However, few indicators indicate a more severe crack in market internals. Next week, the market will provide more clues about what happens next.

The big story this past week was the rapid rotation from the “Mega-cap” stocks to the Russell 2000. That rotation surprised many managers, leading to a rapid derisking of portfolios. To wit:

“The de-grossing activity over the past 5 sessions is the largest since Nov ’22 and ranks in the 99th percentile on a 5-year lookback.”

However, we will explore this week whether this rotation is sustainable or just a function of short-covering.

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