Long-term, the stock market is in an uptrend but extended as noted in the chart below, which goes back to 2008. Note how every major pullback has occurred when the index has reached the top of its up-trending channel. I have notated these tops with a red box. This does not mean that the market can’t continue to advance despite being extended. It is just that the odds of some type of consolidation or pullback are elevated.
Below is a short-term chart of the S&P 500 Index. Notice how the index has been consolidating over the past couple of weeks. It is logical that the market would consolidate here given it is extended.
The Nasdaq 100 Index is also consolidating between support and resistance.
If the market is going to advance despite being overbought, I would expect Small Cap stocks to lead the charge given they have been consolidating for the past three months and are not as overbought as the S&P 500.
That has not happened yet. And as you can see in the chart below, Small Caps (iShares Russell 2000 ETF (NYSE:IWM)) continue to consolidate.
The Bottom Line
Long-term, the market is in a confirmed uptrend. However, short-term it is extended to the upside. As a result, the market may have trouble advancing strongly in the near term without more consolidation or a pullback.
Other technicals also suggest short-term caution such as the VIX, which has started to become positively correlated with the market and is starting to rise. Historically, when I have seen the VIX behave in this manner it has frequently been a precursor to a market pullback or correction.
Also, momentum indicators have been negatively diverging with the market, suggesting an increase in the odds of a near-term pullback in stocks.
One of the main things that I will be watching in the coming weeks is whether the market can advance above resistance. If it can, that would be a strong signal that the broader market is poised for another leg higher. I think this is the lower-odds scenario.
On the other hand, if these major market indexes all begin to fall below their respective levels of support, I believe that would encourage more selling and be a signal that a short-term correction could be at hand.