US Equity Market: The Data and the Anecdotal
By Michael Coolbaugh, Chief Investment Officer
As of this writing, the US equity market appears to be pulling back from what looks to be a feeble attempt at setting new all-time highs (ATHs). The reason I felt it necessary to publish a quick update is because of the general sentiment I’ve been observing over the past several days, coupled with some of the data observations we’ve been discussing with clients.
Before I dive into the data, I’d like to share the anecdotal – the old trading axioms we routinely hear throughout any given day, week, month or year. That axiom? “If a stock, commodity, equity market, etc. can’t fall on increasingly negative news, it’s generally a very bullish signal.” In fact, if you talk to enough traders, you’ll hear them parroting this line given the resilience of the US equity market over the past several weeks. It goes something like this, “If we can’t fall on tariff threats, Deepseek fears, the Fed pausing rate cuts; that’s incredibly bullish for the S&P 500, NASDAQ or whatever.”
I’ll admit – I’ve long used this whole “news versus price action” as part of my trading arsenal. But living and dying by this axiom alone can lead to disastrous results. In the case of tariffs, is it that we can’t fall on tariff fears or rather that the market doesn’t believe the tariff threats because of Trump’s history of quickly backtracking once he’s secured “an amazing deal!”? Just look at the situation with Canada and Mexico. The market quickly retreated on Trump’s announcement that tariffs would go into effect back on February 1. Two brief phone conversations later, those were pushed back at least 30 days. Those reciprocal tariffs President Trump promised as part of his “biggest announcement in history”? Those were also pushed back to April 2 and included very little detail in terms of rates, countries under consideration, on and on.
So, that’s the current set-up. Everyone, particularly the cheerleading permabulls, are busy celebrating every ALL-TIME HIGH. And while they’re busy only looking at “price”, it’s the conditions beneath the surface that has me particularly concerned.
Let’s get into the data. For starters, we can look at various measures of breadth. In the chart below, the lower pane shows the percentage of stocks in the S&P 500 above their 200-day moving average (red), the percentage of stocks in the S&P 500 above their 50-day moving average (black), and the percentage of stocks in the S&P 500 above their 20-day moving average (green). Each of these have their particular importance, but for the sake of clarity, the red line is generally a sign of long-term market breadth (supportive of longer-term trends), the black line represents intermediate-term health, while the green line is more of a short-term oscillator that follows the daily-to-weekly fluctuations in the market.
Source: Strom Capital Management LLC, TradingView
There are a few quick observations to make based off of this chart. First, the strongest forward returns for equity markets tend to follow periods where breadth is deeply oversold (below the 20% threshold in that lower pane). Second, during healthy bullish advances, you want to see that red squiggly line (Pct Above 200dma) holding near the 75% threshold. This is a sign of many stocks remaining within uptrends and thus a positive sign for broad market participation (2024 being a great example).
Where concerns begin to mount is when we have falling participation. Many times, it may be difficult to spot this in real-time as these “breadth” lines tend to follow the oscillations of the broader market. However, it’s when we see divergences that warning signals should begin to pop up in our heads.
On the bullish side, we would want to see a given index hit new lows while breadth does not – you can see how in October 2023, the S&P 500 Index hit a new low, but the percentage of stocks above their 50-day moving average (black line) did not. This was a warning sign that the move lower was becoming exhausted and thus prone to a reversal.
Source: Strom Capital Management LLC, TradingView
On the bearish side, we look for the index hitting a new high, while breadth does not – the rally from mid-October 2024 to late-November 2024 being a recent example. This was a warning that the move higher was becoming exhausted and raised the possibility of a correction or, at the very least, a pause in the rally.
Source: Strom Capital Management LLC, TradingView
Today, here’s what we can see: 1) Only ~60% of stocks are above their 200dma (versus 75% at the December peak); 2) ~60% of stocks are above their 50dma (versus 70% at the late-November peak); and 3) ~55% of stocks are above their 20dma (versus 82% at the January peak). That’s what many will call a “negative breadth divergence.”
Now, a breadth divergence by itself is never a reason to go long or short. But it’s when we factor in a number of other observations that I think the current environment gets particularly difficult.
Here’s just a few observations…
1) There is a negative divergence according to the Dow Theory. Basically, what the Dow Theory says is that, when you have a new high in the Industrial Average that is not confirmed by the Transportation Average (or vice-versa), it should serve as a warning for a potential market correction.
Source: Strom Capital Management LLC, TradingView
2) There is a negative momentum divergence on both a daily basis, as well as a weekly basis. For this, we use the Relative Strength Index (RSI), which is a technical indicator that measures how fast and how much a security’s price changes. The thought amongst many technicians is that momentum tends to be an early warning sign for an impending change of direction. If the moves higher are taking longer and getting smaller (as with the current advance of eeking out minimal gains each day), that’s a “bearish divergence.”
Source: Strom Capital Management LLC, TradingView
3) Homebuilding, Retail and Specialty Chemical stocks have been absolutely battered. Casual observation suggests that it’s a near daily occurrence that several stocks within these industries are experiencing significant downside volatility. Yesterday, we saw severe weakness in Toll Brothers (TOL), Louisiana-Pacific (LPX), and Wingstop (WING) following their respective earnings reports.
Source: Strom Capital Management LLC, TradingView
4) The SKEW-to-VIX ratio has been hovering around levels, which suggests it’s a good time to be long downside volatility protection. The simplest explanation of the SKEW-to-VIX ratio is that it compares deep out-of-the-money options (SKEW = tail risk) versus closer at-the-money options (VIX = normal fluctuations). When this ratio becomes elevated, it’s generally a sign of one of two things – traders see brewing risk for a major event (rising demand for tail protection) or “normal fluctuations” i.e. the VIX is too subdued relative to the broader environment.
Source: Strom Capital Management LLC, TradingView
5) Bank of America’s latest survey of institutional investors shows cash levels are at 15-year lows. According to BofA’s work, periods where cash levels dropped below 4% typically coincided with a temporary market peak. Furthermore, fears of a global recession are at a 3-year low as 36% of respondents see a ‘no-landing’ scenario, while only 6% predict a ‘hard landing’ (recession).
Source: BofA Global Research
Going back to that old trading axiom at the beginning, I mentioned the popular phrase we hear today, “If stocks can’t fall on tariffs, Deepseek, etc., then that must be incredibly bullish.” But remember, these anecdotal observations can work both ways.
What I don’t hear is the following, “If stocks can’t rally on the ‘most pro-business, pro-growth President in all of history’ (according to Bill Ackman and a few others), then…” I’ll leave you to fill in the blank.
That’s right – the S&P 500 Index has gone virtually nowhere since early-December. More troubling is the fact that the “most pro-growth President in all of history” has been met with increasingly negative performance from various cyclical industries that one would expect to benefit the most from major pro-growth policies (even Regional Banks boast a negative return since the market close on November 6, 2024).
As I said before, divergences should never be used in a vacuum to make a major directional call on any market. And, honestly, I don’t know if all these warning signs will result in something so sinister. But if we step back and weigh all of the evidence, here’s what we see…
1) Valuations across a wide variety of metrics are the highest on record.
2) Global investor allocations amongst the most bullish on record.
3) Major technical warning signs from breadth, momentum and inter-market analysis.
4) Caution flags are being waved from the volatility markets.
And that’s just the data. That’s not even factoring in the anecdotal observations of speculative activity in ‘meme stocks’ or ‘meme coins’, the Bank of Japan raising rates (historically, they tend to do so at exactly the wrong time), SoftBank piling in at what looks to be the potential top of a major bubble (look at their history with WeWork, aggressively trading options for the ‘gamma squeeze’ just before the Archegos implosion, Wirecard, etc.), cult stocks like Palantir (PLTR) trading at 80x forward revenue estimates, the fact that cutting all of this “wasteful government spending” might actually have a negative multiplier effect as it provides less capital to be spent into the economy, the list goes on and on.
I get it, being bearish doesn’t generally pay all that well and markets can “remain irrational longer than you can remain solvent”, according to John Maynard Keynes. But being cautious and being bearish are not necessarily the same thing. I do believe there are growing signs to be bearish, but at the very least, I think it’s a pretty good time to exercise a bit of caution.