A lot of things are not “confirming” the stock market’s rally right now.

Standard traders look for “non-confirmations” in the market. They typically plot a fundamental/technical indicator ontop of the S&P 500, demonstrate how the 2 lines have mostly had a strong correlation over the past 2 years, and then demonstrate how the S&P has “diverged” from the indicator recently and how the indicator is not “confirming” the stock market’s rally.

Then, they come to the conclusion that the stock market is going to reverse because “DIVERGENCE!”

In reality, most divergences don’t amount to anything and are not much better than a 50/50 coin toss. These correlations are optical illusions, and work until they don’t.

Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day.

 

*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are blindly “guessing” the future.

Non-confirmation

Baa corporate bond spreads widened when the stock market crashed in Q4 2018. Now that the stock market is rallying, corporate bond spreads are not narrowing significantly.

 

Seeing that Baa spreads and the S&P have mostly had a positive correlation from 2016 – present, some prominent traders are seeing this divergence as a bearish sign of “non-confirmation”.

 

Is it really?

Here’s what happens next to the S&P when the S&P rallies more than 15% over the past 38 days, while Baa spreads narrow by less than -0.1

*Data from 1986 – present

 

This occurred in:

1. now
2. 2009
3. 1998
4. 1997
5. 1986

More bullish than bearish for stocks. Just because there’s a divergence or “non-confirmation”, doesn’t make it useful.

The epic clash between bonds and stocks

In another sign of “non-confirmation”, Treasury yields are not “confirming” the stock market’s rally. Bond yields are falling while stock prices are rallying.

 

 

 

Once again, this “divergence” and “non-confirmation” is not actually bearish for stocks

Here’s what happens next to the S&P when it rallies more than 15% over the past 38 days while TNX (the 10 year yield index) falls more than -3%

*Data from 1962 – present

 

Once again, more bullish than bearish for stocks 3-12 months later.

 

…And also more bearish than bullish for Treasury yields 9-12 months later

Low VIX RSI

As of last Friday, VIX’s 5 weekly RSI is oversold (below 30), after being overbought within the past 3 months

 

Is this a bad sign for the stock market?

Here’s what happens next to the S&P when VIX’s 5 weekly RSI falls under 30, after being above 70 within the past 3 months

 

It is indeed a short term bearish sign for stocks. But 9-12 month forward returns are more bullish than random.

Here’s what happens next to the VIX

 

This is a short term bullish sign for VIX

Breadth

A quick reminder of breadth.

Breadth remains strong, with more than 90% of the S&P 500’s stocks above their 50 dma

 

Here’s what happens next to the S&P when more than 90% of S&P 500 stocks are above their 50 dma

*Data from 2002 – present. Since the data is limited, take this with a grain of salt.

 

As you can see, this is quite bullish for stocks 3-12 months later.

Dow Bollinger Band

The Dow Jones Industrial Average has hit its upper Bollinger Band for the first time since September 2018. Is this a bearish factor for the Dow, as standard technical analysis suggests?

 

Here’s what happens next to the Dow when it closes above its upper Bollinger Band for the first time in 3 months, while above its 200 dma.

 

As you can see, not consistently bearish for stocks on any time frame.

Conclusion

Here is our discretionary market outlook:

1. The U.S. stock market’s long term risk:reward is no longer bullish. In a most optimstic scenario, the bull market probably has 1 year left. Long term risk:reward is more important than trying to predict exact tops and bottoms.
2. The medium term direction (i.e. next 6 months) is mostly neutral. There are a few more medium term bullish studies than medium term bearish studies
3. The stock market’s short term has a bearish lean due to the large probability of a pullback/retest. Focus on the medium-long term (and especially the long term) because the short term is extremely hard to predict.

Goldman Sachs’ Bull/Bear Indicator demonstrates that while the bull market’s top isn’t necessarily in, risk:reward does favor long term bears.