So Many Things Are Not "Confirming" The Stock Market’s Rally

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.

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Our discretionary outlook does not reflect how we trade the markets right now. We trade based on our quantitative trading models. When our ...

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