With the S&P 500 trading about 8% below its all-time high, many traders are worried about a bear market — and for good reason.Stocks are overvalued on fundamental measures. Inflation is hurting consumers and that could drive sentiment into bearish territory. At the same time, the Federal Reserve is raising interest rates for the first time in years. That is making mortgages more expensive and could hurt the housing market. I could go on, but it’s enough to know the list of worries is long and seems to grow longer every day. Here’s the thing, though: These factors matter… but they’re hardly the way to predict the next trend. Whether or not we’re in for a bear market depends on one obvious fact. And yet it’s somehow overlooked by the majority of traders…
Market Breadth Isn’t Screaming Bear
To determine the next trend, all you need to do is identify whether the majority of stocks are going up or down.This requires a useful tool called breadth indicators. Market breadth looks at how many individual stocks are in uptrends or downtrends. There are many breadth indicators but they all tend to give signals around the same time. One of the clearest signals comes from the percent of stocks above their 200-day moving average (MA). The 200-day MA defines the direction of the trend. When prices are above the MA, the stock is in an uptrend. A downtrend is when the price is below the 200-day MA. These simple definitions extend to the broad stock market. When the majority of stocks are in uptrends, it’s a bull market. A bear market occurs when the majority of stocks are in downtrends. The chart below shows that 48% of the stocks in the S&P 500 are trading above their 200-day MA. While this is mildly bearish, the pattern shows that buying and selling pressures are relatively balanced.
In the next few weeks, I expect that balance to give way to a strong uptrend.The most recent bear market ended in March 2020. At that time, the percentage of stocks above their 200-day MA fell rapidly. Contrast that to recent months, when the trend has been more orderly. Although the indicator dipped below 50% in January, it has whipsawed above and below that level several times since then. Bears have been unable to take charge of this market. That means bulls are most likely to drive the next trend. While I expect an uptrend, I’ll trade the indicators. A decisive breakdown in breadth will make me bearish. But we don’t have that yet.
Regards,Michael Carr, CMT, CFTe Editor, One Trade
Chart of the Day:How Stocks Are Dealing With Inflation
By Mike Merson, Managing Editor, True Options Masters
Earlier this morning, Consumer Price Index data for March came out at 8.5%, another 40-year high.And stocks seem to love it. The S&P 500 is set to recover all of its losses from yesterday on today’s open. That’s no surprise. High-inflation conditions should urge more investment into stocks and encourage spending — people won’t be keen to hold off on purchases if they’re likely to be pricier in the future. Where this does cause concern is with the Fed. Higher inflation means more pressure for the Fed to hike interest rates. Stocks have taken this in stride so far, but there’s always a threshold where the rate hikes become too much to bear and stocks sell off (see December 2018). We’re not anywhere close to that yet. And hopefully the Fed can break the cycle of lower highs in interest rates without causing a recession, if we’re ever really going to get the economy back on track.
Mike Merson Managing Editor, True Options Masters