• Money started to rotate out of semiconductors, which many see as a weakening signal in the stock market.
  • Consumer Discretionary trying to join short-term relative leaders.
  • Technology remains a short-term relative leader.
  • Momentum is building in energy, but the sector does not have enough relative strength.

Since the S&P 500 Index embarked on its recovery journey in late October 2023, it has demonstrated remarkable resilience. Despite experiencing a sharp upward movement in November and early December, followed by a consolidation phase in late December to mid-January and some volatility in February, the index managed to pull back only about 6% in March/April. It then faced another setback, losing almost 3% in late May. However, the index has been consolidating in a horizontal price move throughout June, reaching its all-time high (ATH) at 5523.64. The consistent factor during this uptrend has been the lack of participation of many stocks, a condition often referred to as poor “breadth” and narrow participation.

The S&P 500 Index is up about 14.4% year-to-date (YTD). Some leading stocks, such as Super Micro Computer (SMCI), are pulling back from their March ATH, but the stock price is nicely consolidating on a horizontal pattern. Invidia (NVDA) had a couple of rough weeks after reaching its ATH in mid-June, dropping about 17% in two days.

The S&P 500 Index breadth condition is mixed, with almost 70% of stocks trading above their 200-day moving average (MA). Generally, a sustainable bull market needs over 50% of stocks trading above the 200-day MA. However, only 50% of stocks are trading above their 50-day MA, which, in my opinion, is substantially less than the minimum requirement. In a stock market showing mixed breadth conditions, where 50% of the stocks in the index are not participating in the short-term uptrend, it’s essential to remain patient and stay invested in those stocks showing strength. During the slowness of the summer months, the S&P 500 could either debilitate more or regain strength and breadth. The key is to remain invested in those stocks showing strength, regardless of high valuations and not to try to guess the next big winner. The market will severely punish you if you err on your winning stock selection. Therefore, it’s crucial to stay invested in those stocks showing strength until you see a change in pattern.

Over the last couple of weeks, the stock market has shown signs of money rotating out of specific sectors and stocks and into other sectors and stocks. Semiconductors, including stocks like NVDA, have suffered an outflow of capital. Some investors see this as a sign of a weakening stock market ready to pull back from its ATH. Maybe this is true, but Consumer Discretionary (XLY) has seen capital inflows during the same period. This is important because the sector is about two-thirds of the S&P 500 Index and the U.S. economy.

Although, during the last two weeks, the Semiconductor industry has been weakening relative to the S&P 500, Technology (XLK) as a sector remains a short-term relative leader. Furthermore, capital inflow is rotating into the Software industry. The sustainability of this trend is essential because Technology is almost 30% of the S&P 500 Index. If the trends in the Consumer Discretionary and Technology sectors remain positive, it should be challenging for the bears to regain control of the stock market.

Last but not least, the Energy sector (XLE) seems to be in the early stages of regaining its relative strength compared to the S&P 500 Index. During the third phase (Phase III) of the economic cycle, energy usually regains price momentum, where economic growth decelerates and inflation accelerates. We’ve noticed a weakening industrial sector (XLI) and transport sector ($TRAN), typical of Phase III. This is usually a confusing part of the economic cycle and difficult for many investors to manage. Therefore, if these trends continue, volatility ($VIX) may also regain momentum and spike up during the slowness of the summer months. Keep in mind that historically speaking, September is quite volatile. Regardless, growth and momentum should be the investment theme during Phase III.

Although the S&P 500 and many stocks are experiencing ATHs with narrowing participation, we do not expect a short-term bear market to ensue. We may encounter higher volatility and stock market pullbacks. However, if current conditions remain, those pullbacks should be an opportunity to add risk to portfolios while monitoring the inverted yield curve in anticipation of an economic recession, the trends of the U.S. dollar, inflation, the 10-year U.S. Treasury yield, and volatility. These are the real threats to the current bull market, not the rotation of capital out of semiconductors and narrow participation.

Please remember that our forecast may change as economic data becomes available.

Consider not being fully invested, taking on smaller position sizes, and holding a higher cash allocation.

Thank you for the opportunity to serve you. We appreciate your confidence and trust in our conservative investment strategy and risk management approach while dealing with the inevitable volatility of financial markets. We are grateful for your trust in our team.

Please feel free to contact us should your personal circumstances change or if you have any questions.

Check the Main Trends of stock indices, volatility, yield, currencies, and more here.

(*) The Greenwich Creek Capital “Index Trend Table” is not meant to be used in isolation, it is part of a more complex set of variables and it is not designed to provide trade entry and exit points.

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Saul A. Padilla, RIA

Saul A. Padilla, RIA

Registered Investment Adviser and founder of Greenwich Creek Capital Management LLC, bringing over 37 years of experience in managing discretionary and non-discretionary investment portfolios for wealthy families and institutions. His main focus is to protect invested capital by re-balancing the allocation of cash, equities, fixed income and commodities, while closely monitoring macro-economic indicators and market trends to determine the transition phase between the completion of a Bull Market and the beginning of a Bear Market. He started his career in early 1987 mainly managing family financial investments.