Last week was full of newsworthy items: Trump met with the EU and all indications point to possibly avoiding a trade war with the EU, GDP came out indicating that second quarter growth was up to 4.1%, earnings was a mixed bag of great and greatly disappointing. What about the overall market?
There are a few different ways we can look at the markets: market breadth and market sentiment. Market breadth refers to how many of the stocks out there are trading upwards relative to those trading downwards. Market sentiment has to do with investor psychology or another way to describe it could be tone of the markets.
The bottom line is that market breadth is really a mixed bag, but not a bad thing at this point. Market sentiment, on the other hand, should be watched. As we move towards recovery from the market correction that began late January 2018, these are very important topics as we gauge the probability of continued advances and the overall market health.
Looking at market breadth, we can see that market breadth is not that bad. The S&P 500 has remained above the 50-day moving average, and the advancing stock relative to declining stock has also remained above its 50-day moving average. Only the S&P 500 relative to Ned Davis Research’s US Large Cap Cap-Weighted Index is below its 50-day moving average, indicating the recover is not yet completely over.
Market sentiment is really what’s more concerning. When we look at market sentiment, even with the economic backdrop we have now with good 2Q GDP numbers and the tax cuts, sentiment is dangerously close to excessive optimism. This could imply that there could be better chance of investor disappointment than a surprisingly great return.
This is not implying that the end of the expansion is upon us, but rather another indicator that risks are rising and not falling. At the end of last week, this is what the market sentiment looks like when plotted on a graph. You can notice that the sentiment has risen since the lows early in 2018 but have gotten close to being excessive again.
While these measures of market health are not currently indicating that we are likely to have explosive growth, they are also telling us that we are likely not entering a bear market. What it is telling us is that we are in a market that is lacking a clear and determined trend. Until we see evidence of a change of direction, we interpret these two measures considering the greater trend that remains positive.
Markets can break out to the upside and make new highs, but given that we have not seen phenomenal participation in the number of stocks making new highs versus those making new lows, it is most likely that there is some limit on how high we can get within the stock market, absent more positive signs.
We have yet to reach the market levels of late January and the market has also showed increased risk that the environment can deteriorate. This means heightened volatility is likely to remain for some time.
Keep in mind that this is very normal for a mid-term election year and summertime, which basically means that even when you feel like it is different this time, it really is quite normal. Normal is not always fun, but that is how it is.
Depending on where you live, I hope that this summer is bringing you some relief from the heat (hot climates) and some opportunity to recharge and get ready for the fall! Mid-term election years typically have their best returns later in the year when companies know what the legislative environment might look like.
So hang in there and check in with us for the latest market updates!
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