May Technical Market Outlook

Sometimes the best thing you can do is nothing.

As investors and analysts, we’re under lots of pressure to keep up with a rapidly changing environment . Information is more readily available than ever before, and the flow of new data is never ending. Market prices are constantly shifting, forcing us to constantly reevaluate our investment outlook and portfolio positioning. With the world changing so quickly around us, it often feels like we need to be changing and doing things, too. But sometimes the most helpful course of action is to take no action at all.

That’s where we find ourselves today.

At the start of each month, we take a top-down look at the US financial markets and ask ourselves: Is this a time to buying stocks and increasing our exposure to risk? Or are we better served looking for stocks to sell and finding alternative places to invest?

For each of the last 5 months, we’ve given the same answer: if the S&P 500 is above the resistance area near the 161.8% Fibonacci retracement from the COVID selloff, then we can have increased confidence that the bear market has run its course, and we can err toward buying stocks.

During those 5 months, plenty has changed. Sentiment regarding the macro environment has gone from ‘imminent recession’, to ‘probable soft landing’, to ‘no landing’, and back to ‘imminent recession’. But Mr. Market has never been one to track the economy step for step. That’s why we watch prices so closely here at Grindstone, in addition to monitoring the macro environment. And prices haven’t really changed at all.

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The S&P 500 is still trying to absorb overhead supply. If we’re above that 14-month rotational area, then we want to be buying stocks. It’s that simple. On a breakout, we can have a longer-term target for the S&P 500 of 5300. That level is the 261.8% retracement from the 2020 decline, and represents a gain of roughly 25% from current levels. If we’re below the February 2 highs, though, there’s no reason to be aggressively buying stocks.

The NASDAQ is in the same situation. Once again, we’re looking at those February highs, which line up with the 161.8% retracement from the COVID selloff and also marked the September 2020 peak. That September high has a lot of importance because it marked the end of a 15-year bull run for growth stocks relative to value. If we’re above that key level, how could we possibly be bearish?

The value-heavy Dow Jones Industrial Average is challenging resistance, too. There’s no need to repeat everything we’ve already said about the S&P 500 and the NASDAQ – our line in the sand here is 34,000.

The bull case is clear: one good day for stocks would push all 3 large cap indexes above their key levels.

So what about the bear case? We think it has to start with the small caps. The Russell 2000 has lagged all year, and it was testing lows just a week ago. That stands in stark contrast to the strength we’ve seen out of large caps.

If the Russell is beneath its March lows, you’ll have a tough time convincing us that stocks overall are heading higher – you just don’t see major indexes setting new lows in a bull market.

In that bear scenario, the next shoe to drop would be the Financials. When you thing about important levels for financial stocks, it’s hard to think of one with more relevance than the 2007 highs. And wouldn’t you know it, the S&P 500 Financials sector has been basing above those ’07 highs for most of the last year. Stock prices have memory!

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If Financials are falling below multi-decade support, we’re willing to bet that all those large cap indexes aren’t breaking out. In fact, a retest of last year’s bear market lows would be the more likely outcome. We can’t be bullish if Financials are below their 2007 highs.

Our neutral approach toward stocks has worked out well for us so far, and the market hasn’t given us a good reason to change our minds. We know exactly what we want to see before turning more bullish, and we know exactly what we’re watching for signs of a renewed bear market. Neither of those things are happening right now.

The best thing to do is nothing.

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