S&P 500: A Minor Pullback, Then...

After the SPX tested all-time highs on Wednesday, it was not surprising to see the major US stock market averages pull back on Thursday. The decline was surprisingly light. What I found supportive of the bull case was the upside breakouts shown by the high-beta leadership such as the NASDAQ and small caps.

Consider, for example, the chart below of the NASDAQ 100. Not only did the upside breakout hold, the index went on to further new highs on Thursday. However, these upside breakouts were staged on falling volume, which suggests that a near-term pullback may be necessary before stock prices move to sustainable new highs.

This chart of the Russell 2000 small cap ETF (IWM) shows a similar pattern of further breakouts on Thursday, but on low volume.

On an intermediate term basis, cyclical stocks remain in a relative uptrend compared to the broad market, indicating that Mr. Market still believes that economic growth is undergoing a period of acceleration.

This week is option expiry week, which tends to have an upward bias. The week after option expiry has tended to have a negative bias for the market. The current market action is highly suggestive of a minor pullback next week.

Even though my base case calls for further highs in stock prices, I am cognizant of a bear case for equities. If the forecast weakness were to occur next week, I would closely watch sentiment model readings for direction. Hays Advisory correctly pointed out that sentiment models showing a crowded long reading. If bullishness were to pull back with prices, then I would see that as a green light to go long. On the other hand, if the level of bullishness were to stay stubbornly high, then it would be a warning that an intermediate term market top may be in place.

Disclosure: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

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