After A Textbook Pullback, It’s Time To Get Bullish About The Market
After five straight days of losses, the SPDR S&P 500 ETF (NYSE: SPY) is at support. The ETF is in a relatively strong technical position despite the pullback.
Friday’s low coincided with the August 23 low. That day, SPY gapped higher, and the rally pushed the ETF to a new all-time high. After reaching that high, we have had a pullback that retraced 50% of the prior advance. The pullback itself pushed the ETF about 1.9% below its all-time high.
Despite the length of the pullback, none of this is particularly bearish. Pullbacks are normal and, so far, the retracement has unfolded in textbook fashion, stopping at support.
Of course, we still need to watch carefully this week.
“Risk On” Trading Makes A Comeback
Interestingly, traders seem to be adding aggressive positions to their portfolios. The chart of the NYSE FANG+ Index below shows that traders have pushed this index of the most aggressive stocks to new highs.
At the bottom of the chart is my Income Trader Volatility (ITV) indicator, which remains bullish on the index.
ITV is similar to VIX in that it rises as prices fall. Its current position, with the indicator (red line) below the moving average (blue line), points to continued strength in the market leaders.
ITV is at a relatively low level. In the past, we’ve often seen brief consolidations after the indicator reaches an extreme low like this. An interesting feature of this indicator is the fact that steep market selloffs tend to occur when the value of the MA is relatively low, as it is now. The current value of the MA and the position of the indicator is consistent with a consolidation.
My bullish outlook is confirmed by the bond market. The next chart applies ITV to the yield on 10-year Treasury notes.
In the bottom panel of this chart, you can see that ITV appears set to drop below its MA and that indicates we should see higher rates. That’s bullish for stocks since higher interest rates are consistent with economic expansion.
Just to clarify, I am not looking for interest rates to return to normal or for the Federal Reserve to raise rates.
Even normal interest rates would be significantly higher than where we are now. That’s because normal rates are higher than expected inflation. Bond prices indicate traders expect inflation to average 2.4% a year over the next 10 years. That implies the normal interest rate on the 10-year note should be at least 3%.
We are unlikely to see rates at that level for some time because the Federal Reserve is taking action to keep rates down. Fed policy to maintain low rates is likely to remain in place for years. This means rates will move up and down in a narrow range… but increases in rates will still be associated with economic expansion, which is bullish for stocks.
How I’m Trading Right Now
As always, for the short-term outlook, I want to look at my indicators.
ITV remains bullish for SPY.
Its current position, with the indicator (red line) below the moving average (blue line) but potentially prepared to break above the MA, is worrisome. However, it is bullish until the breakout occurs.
Looking at my Profit Amplifier Momentum (PAM), last week’s price action in the S&P 500 reversed our recent “buy” signal.
PAM is designed as a short-term indicator. Its recent drop reflects the sharp, five-day move in SPY.
We will look for confirmation of weakness in the next week but, for now, based on my indicators, I remain slightly bullish on the S&P 500 in the short term.
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