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What Are Doom And Gloom Forecasters Missing?

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The stock market rally stalled on Friday as the positive monthly jobs report increased fears that the Fed’s efforts to lower inflation would be more difficult. Those who think we are already in a recession did not question the 1.63% decline in the S&P 500 but may have second-guessed their economic outlook.

Many of the recent economic reports are also not giving recession warnings as last week’s ISM Manufacturing Index came in better than expected at 56.1. The 50 level is considered the key level as a drop below it signals contraction of the manufacturing sector. It was just above 40 at the Covid low and was below 35 in 2008.

Not all of the data has been strong as the Consumer Confidence has dropped to a three month low as inflation has strained many budgets. The University of Michigan's Consumer Sentiment finished May at 61 and is already close to the March 2009 low of 58.3. The next reading on Consumer Sentiment is released this Friday along with the CPI report which will be a greater challenge for both the stock market and economy.

Last week’s best performer was the Dow Jones Transportation Average which was unchanged. Leading the market lower was the Dow Jones Utility Average which was down 1.5% but it is still up 4% year-to-date (YTD).

The S&P 500 was down 1.2% followed closely by a 1.1% decline in the Nasdaq 100 Index which is now down 23.1% YTD. The Dow Industrial Average held up better losing just 0.9% and is now showing a 9.5% loss for the YTD. The iShares Russell 2000 was down just 0.3% for the week.

The current prevailing opinion is that the rally that began on May 23rd is just a bear market rally that will be followed by new lows. An interesting article from Sentiment Trader reported that the “number of articles dismissing the gains as just another "bear market rally" is nearly double the prior record from early April 2020”. Another peak coincided with the late 2018 low. Both turned out to be good buying opportunities.

The data used from Bloomberg suggests there were over 800 such articles. I have only read a fraction of these articles but very few authors revealed what it would take to change their view. This is an advantage that technical analysts have over fundamental analysts. I have always believed that it is essential to have an exit plan and that stops are required.

If the S&P 500 closes below 3810 and the Nasdaq 100 closes below 11,492 along with a close in the NYSE Composite below 14,695, the stock market's major downtrend will be confirmed. If the S&P 500 Advance/Decline line were to make a new low for the year I would come to the same conclusion.

Many who favor the bear market rally scenario allow for a S&P 500 rally back to the 4300 area, line a, before the bear market rally is over. For me, a move above the March high at 4637.30 would be enough to conclude that the market was headed to new highs.

I have yet to see a discussion or explanation of why the very low sentiment readings from both the individual as well as professional money managers are not material. As I have pointed out repeatedly over the past month or so some of the readings have already reached historic levels.

The latest survey from the American Association of Individual Investors (AAII) revealed an increase in the bullish % to 32% from the prior week’s reading of 19.8%. More important is the fact that the April 13th reading of 15.8%, point 1, was the lowest reading since 1993. It was also “among the lowest 10 readings in the survey’s history”.

For some added perspective it was lower than any level seen during the 2000 or 2008 bear market. Often the bullish % will bottom ahead of the market which was the case in December 2018.

Given the preponderance of views expecting a bear market rally, it is not surprising the investment managers are also quite pessimistic. The NAAIM (National Association of Active Investment Managers) index exposure level hit 19.5 at the low (point 3) and was just above 33 last week. At the March 2020 market low it was 10.62.

In the most recent BofA survey of investment managers that control just under $1 trillion reveals they have the lowest equity exposure since May 2020. The very high cash levels are also consistent with a market low. Even BofA commented that the “May fund manager survey is "extremely bearish".

On the NYSE last week 1520 issues were advancing and 1977 declining. The weekly S&P 500 A/D line did decline slightly but is still above its EMA and the support at line a. A move above the two week high this week would be bullish while a break of support, line a, would be negative.

As I pointed out last week the buying was very heavy over a week ago with over 90% of the S&P 500 and Nasdaq 100 stocks advancing on Friday May 27th. This is supported by the Zweig Breadth Thrust Indicator. It went from below 41 to over 61.5 in ten trading sessions. This move from very oversold to very overbought is a somewhat rare signal that was developed by the late Dr. Martin Zweig. Historically these bursts of strong buying often translate into positive returns in the weeks and months ahead.

So what am I watching in the week ahead? Even with Friday’s selling most of the averages did not drop below their 20 day EMAs or the new monthly pivots. That is an encouraging sign but it could be reversed with selling on Monday.

The yield on the 10-Year T-Note rose last week as concerns over additional rate hikes had a negative impact on the stock market. The yield closed just below the resistance at 3.023%, line a, so the action early this week will be important. A close back below 2.833% will suggest that the rebound is over. The MACDs did improve on the rally and could turn positive if yields stay higher early in the week. They did form a negative divergence at the recent high, line b.

I am also watching the VIX which closed below 25 last week. There is chart support in the 23.40 area and a declining VIX is typically a good sign for stocks. The MACDs are still negative for the VIX and show no signs of bottoming.

It should be another interesting week as there were a few more corporate leaders who voiced their increasingly negative economic outlook. In decades of following the stock market and economy, I do not remember a period which such a uniform economic view turned out to be correct. It certainly was not the case during the bear market rally in the spring of 2008 as most analysts and CEOs did not think the Bear Stearns collapse in March 2008 was sending a warning for the economy.

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