Will the fireworks continue into the week of the Fourth of July? After a lower Monday open, the seasonal post-June OPEX low since 1993 was pinpoint accurate as the S&P 500 Index (SPX--4,450.38) bounced at the August 2022 highs near the 20-day moving average and by Friday, closed at new 52-week highs.
Why does this happen? It can largely be attributed to quarter-end buying from funds as we head into July, which happens to be the second most bullish month on average for the equities. Over the past 10-years, July has been positive 90% of the time by an average of 3.1%, and in particular, the next two weeks being the strongest -- with this week being positive 80% of the time by an average of +1.22%, and next week being positive 90% of the time by an average +1.11%, over the last 10-years.
If equities continue to bring the heat into mid-summer, a reasonable upside target is the September 2021, February 2022, and March 2022 resistance zone between 4,550-4,600. Considering July's average seasonal gain, as listed above, this 2% to 4% move higher seems attainable by July OPEX. Looking at short interest on the components of the SPX and Nasdaq 100 Index (NDX -- 15,179.21), we find that short sellers are just now starting to throw in the towel. This comes as short interest rolls over from the prior 2022 high in the SPX, and from a multi-year high in the NDX that remains in the 99th percentile from the past 5 years of data. In other words, plenty of fuel still exists for the market to melt higher.
"With the rally driven by only a few companies across a narrow set of sectors, the broader market has a bad breadth problem. If these select few stocks fail to deliver on heightened earnings expectations, the broad market may be primed for a pullback," wrote Seema Shah, chief global strategist of Principal Asset Management.
- Barron's, June 26, 2023
Moreover, we are finally seeing some breadth expansion with other sectors like consumer discretionary, materials, and industrials putting in a solid few weeks now and outpacing technology on a three-week basis. Even financials seem to have stabilized -- the canary in the coal mine that was supposed to send equities back into a bear market finished the week strong. Yet, we have strategists still citing bad breadth as a major cause for concern that this rally isn't sustainable. While this may be the case in the Nasdaq (as evidenced by the negative divergence in its Advanced-Decline Line), the S&P 500 Advance-Decline Line bounced back from a potential failed breakout last week, a clearer representation of the broader market.
Furthermore, the percentage of stocks positive in the S&P 500 over the past three months were around 60% coming into last week. This is certainly higher after last week's price action, where we saw the S&P 500 Equal-Weight Index (RSP -- 149.64) (+3.36%) outpace the S&P 500 (+2.35%). On top of that, the percentage of stocks above the 200-day moving average in the S&P 500 went from 55% to 66%, as individual equities continued to recover the major daily moving average.
Finally, looking at the intermarket relationships like the SPDR S&P 500 ETF Trust/iShares Core U.S. Aggregate Bond ETF (SPY -- 443.28 / AGG -- 97.95) ratio, we see a breakout from an 18-month consolidation indicating investors want to be overweight stocks vs. bonds. Another ratio I like to use is Discretionary vs. Staple stocks, and since we've been hearing so much about the lack of breadth, maybe a better way to look at this ratio is through the equal-weight counterparts. Even here, we see a clear downtrend breakout where cyclical discretionary stocks are exhibiting relative strength. This is what we should be seeing in bull markets.
However, many risks remain when looking at economic data. Multiple early warning recession indicators are still present, with some worsening. While we won't dive into these in this weekly commentary, there are signals that this rally is getting stretched. In past weeks we noted the S&P 500 is overbought; however, it can remain overbought for a while. If equities want to catch bullish investors offside, this is the time to do it with everything we outlined above, as everything points to a bullish continuation in July.
When we look at the SPX Component 10-day buy-to-open put/call volume ratio (0.56), the risk grows if there is a technical breakdown as it turns higher from lows we haven't seen in nearly 14 months. So, while we staved off last week's "Uncle" levels for now, a break of the 4,290-4,300 - roughly 20% above the 2022 closing low – would likely set us up for a retest of the 4,167-4,195 breakout range that cap gains for most of the year. This would also coincide with the break of the SPY 430-strike put open interest level and opening a move down to the peak put level for July expiration at the 420-strike. A move back to these levels isn't irregular for bull markets, with it only being roughly a 6% correction; however, a further breakdown would cast serious doubts that this bull rally can continue.
If there is one thing that has me worried about the bulls' continuation, it's that small caps did not lead us out of this bear market. Nearly every meaningful bull market is led by small caps. The Russell 2000 Index (RUT -- 1,888.73) remains very much in a range and has yet to eclipse the +10% YTD level. One thing that is holding back the RUT is the fallout from the banking crisis experienced earlier this year. In general, banks still look weak, with few exceptions. Maybe these few leaders can get the rest out of the gutter, or perhaps they are just the exception…
Such risk may warrant a hedge to your long portfolio as you buy stocks you like on the pullback. But as I stated last week, unless major support areas are pierced to the downside, particularly the 4,160 level, do not disturb long positions and/or consider using pullbacks as buying opportunities amid the doom and gloom warnings from strategists.
-Monday Morning Outlook, June 26, 2023
So, while this very well could be an odd bull where we see small-caps catch up, it does place some hesitancy on how long this bull market will last. It's also possible that's the wall of worry the market needs to keep climbing higher. Until we see how a larger correction is handled, there is no need to dispose of longer-term bull positions, but I'll reiterate last week's suggestion that if we break the SPX 4,290-4,300 level, a hedge might be appropriate. However, if the bullish momentum continues into July, target upside breakouts with the understanding that the tides could change after July OPEX.
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