🍔Unstoppable Force: Bull Run Far From Over
🍔Unstoppable Force: Bull Run Far From Over
We managed to stay invested in this market by following the trend
Welcome back Investors, and welcome to all the new subscribers over the last few days!
In our last post “What Economists Got Wrong” we covered the fundamental story for the bull market we’re currently in. Today, we cover the technical side. Technicals are not just about drawing lines on a chart; they include analysis of market internals and participant behavior. For our newer subscribers, our post “How I Make Money by Trading with Context” explains why we use fundamentals + technicals to determine the context of the mkt:
Trading with the context helps stack the deck in your favor and increases the odds of a trade working. We are not trading in a vacuum! Understand the environment you're in and adjust your strategy to fit the environment; use the right tool for the right job. This can often make the difference between profitable and unprofitable.
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All signs point to bull
Back in Oct 2022, we saw a series of breadth thrusts and follow-through days (circled below) which preceded a dramatic recovery. These signals fire when large buying activity occurs, often marking market bottoms. A breadth thrust occurs when the vast majority of stocks (>90%) move up in tandem. A follow-through day occurs on a large price move accompanied by elevated volumes. Both are key signs of changing market sentiment, as confirmed by the subsequent run-up.
Then there was a normal 3-wave pullback from Aug-Nov 2023 (seasonally weak months) before new breadth thrusts fired (circled below). Note the 200d moving average acted as support. The SPX then rode the 21d moving average, a line that defines bull market uptrends, to all time highs. This ignited the “everything rally” that drove cyclicals and small caps upwards.
Breadth thrust signals are good for about a years’ worth of >20% performance. That doesn’t mean we can’t have interim drawdowns, like in April 2024 when the market got spooked over slowing economic growth (if you read our last article, we explained why this was only a red herring!)
With the strong economy, Fed set to cut rates, corporate earnings good, and bullish technicals, we can expect this bull market to continue. That means traders should be on the long side, and investors should be overweight equities within their asset allocation and have minimal cash on the sidelines. You do not want to be one of those people screaming for a top and missing out on the biggest rally of the decade!
Bad Breadth
It’s unbelievable how many people complain about bad breadth or the “narrowness” of the market. For those unfamiliar, this simply means the S&P500’s strong performance is driven by just a few stocks - in this case the Magnificent 7. Here’s one such chart demonstrating the narrowness - S&P500 relative to the Equal Weight index which is at new heights:
Yes it’s true breadth is narrow, and this CAN lead to bad things (for example the 2022 meltdown). But look far enough and the track record is spotty at best. Poor breadth in itself doesn’t mean the market is going to immediately correct - only about a 50/50 chance. Instead, the leaders can stay in the lead for very long periods of time. This shorting the Mag7 will be a very painful endeavor.
The better way to play this narrow market is to simply buy the leaders. Why go against them when no other stocks are working? Not only are the technicals in your favor, there are good fundamental reasons too. When the economy is slowing and interest rates are volatile, large cap tech performs well. Add the fact that AI is a tectonic shift and you have a recipe for continued outperformance.
The corollary of bad breadth is that the small cap index, IWM, has been underperforming the SPX. Small caps thrive on two things: economic growth and low interest rates. IWM briefly rallied in late 2023 when Powell pivoted and again with the soft CPI print last week. I think this rally has legs if the economy re-accelerates, but I would be buying pullbacks in case of weak data releases over the next few weeks.
One last thing about breadth: If it wasn’t for the astounding performance of AI, the rest of the market wouldn’t look so bad in comparison. S&P493 earnings growth is slower, but not negative. Many stocks are holding above their 50d and 200d moving averages. A whopping third of the S&P500 is up more than 10% in 2024, and half of those are up more than 20%! We think the breadth arguments are misguided.
This signal tells us market weakness is coming
In my experience it is easier to call bottoms than tops. That is because of inherent mkt biases and the nature of humans to overreact to losses. Capitulation is a thing, as indicated by deeply oversold conditions. Furthermore, bull markets can stay overbought for VERY long periods of time, meaning top signals are less reliable.
Options skew (yellow line in the chart above) is a “topping” signal that I like to use for short-term trading. It measures the cost of hedging using deep-out-of-the-money put options. Every time this signal spikes (red circles) the market will either go down or sideways (red arrows). This intuitively makes sense because traders scramble for hedges, which sucks out buying flows.
During these periods that typically last 5-10 days, traders should switch to mean-reversion trades while investors should be on alert for an exit signal (e.g. break of 50d moving average). We just triggered a spike in skew on July 10, which means the next week should be choppy. Monitor how the market performs, and it will tell you whether to buy the dip or brace for a deeper pullback. I will comment on these occurrences in Substack Notes or Twitter so be sure to follow me there.
We have some other topping signals that we will share with you in the next post, but for now suffice it to say that none of them are giving us pause about the longer term uptrend.
Positioning is like knowing your opponent’s hand in poker…
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Positioning is like knowing your opponent’s hand in poker. For example, if the plurality of investors and traders are in cash, then the deployment of that cash will likely propel risky assets higher. If people are already max long, then we need to be wary of a liquidation when everyone rushes for the exits.
There are a couple of ways to decode positioning. Some examples are: futures positioning data, margin leverage levels, AAII sentiment, hedge fund positions, trend-follower positions, and options put/call ratios. Again, positioning can be a great bottoming signal, but doesn’t always work as a topping signal. This is because the market can be exuberant for extended periods of time.
Our positioning indicators at the moment are indeed high, but not at extremes. Meaning, market participants are indeed bullish but there is still some room to rise. For example, below is the institutional asset managers’ positioning in SPX futures. It’s high, but not crazy high. We can continue buying without being concerned about overbought conditions.
One sector to rule them all
We look at sector and subsector performance (relative to SPX) to understand what the internals are telling us. Year-to-date, all sectors have underperformed except for tech. Factor-wise: value, high beta, low volatility, small caps, everything has sucked wind except for momentum, growth, and size. This goes back to the market breadth issues discussed earlier.
One of these things is not like the other! Tech is literally the only sector to find stocks going up (save for some short-lived moves in commodities). When the fish are swimming in one barrel, you shoot in that barrel! This is why we advocate continuing to own/trade the large cap tech stocks - the fundamentals and technicals are still aligned.
However, we are at a turning point. Remember the small cap rally initiated last week by the cool CPI print? We are seeing similar perk-ups in small banks (KRE), industrials (XLI), utilities (XLU), real estate (XLRE), high beta (SPHB), value (IVE), transports (XTN), homebuilders (XHB), renewables (ICLN), biotech (XBI). Basically smalls and cyclicals, all at the expense of tech. These are the areas that you want to start fishing for ideas in case the rotation has legs.
That’s all for now!
We have a lot more content coming over the next few weeks. If you enjoyed this post, give us a like and a follow on Twitter @mktcontext. Until next time, good luck trading!
Disclaimer: This publication is for educational purposes only. The authors are not investment advisors and nothing here is investment advice. Always do your own due diligence.