The markets head into this shortened trading week with some very extreme feelings.
Just last week we saw three different Wall Street firms switch their posture from bearish to bullish as the "acceptance" phase of the market rally is really kicking into high gear.
"What's the acceptance phase?"
Well, I'm glad you asked.
Let's talk about the psychology of trading and investing for a minute.
The market follows a very defined cycle from bottom to top and then back to bottom. Each stage of the cycle is marked by certain behaviors by investors. A picture can speak a thousand words, so here's what the psychology picture looks like:
The concept is simple.
There's no math involved. There's no one indicator. Tracking market sentiment like this is all intuition that is learned from years of study. I've been studying this for more than 20 years, so you're in good hands.
Let's dive in and I'll show you why this rally is happening and where it's going in the coming weeks
Earlier this year, in March, we had a great short-term setup.
Investors were feeling incredibly nervous about the upcoming earnings season that started the second week of April. Those nerves caused a rash of selling that took the SPDR S&P 500 ETF Trust (SPY) to a short-term market bottom of around $380.
That $380 matched the same lows that we saw in December 2022.
Believe it or not, it was that moment that marked a short-term "despair" situation for both investors and traders.
Think about it, we were heading into earnings season. The market was enduring a crisis as the regional banks were melting down after multiple bank failures. Analysts and the media were hyping very low expectations as inflation and a slowing economy were set to take a toll on corporate earnings and guidance.
Everyone had that feeling of "here we go again, the market's set to get hit!".
But that didn't happen.
Instead, corporate earnings came in better than expected, essentially surprising investors and catching the traders on the wrong side of the market. Frankly, I was one of them.
We started to see all those fears and worries unwind as investors suddenly felt as though the storms had passed.
Add to that the fact that Artificial Intelligence (A.I.) took the market by storm. That provided a "fear of missing out" catalyst that the market hasn't seen since the S&P 500 peaked in December 2021.
Here's an interesting statistic from Factset. A search of all the conference call transcripts for all the S&P 500 companies that reported between March 15 and May 25 showed that 110 companies cited "AI" during their call.
If you're trying to keep up with the "psychology trade" that simple stat is the catalyst that pushed the market from a "disbelief" rally straight to acceptance.
Here's an updated chart of the Sentiment Cycles with SPY.
So where does that put us right now?
The last 5% push that we've seen the market make is key.
During this move, we've seen the rally expand beyond the 7-10 large-cap technology companies that had been doing all the market's work. This expanding rally is a signature of "acceptance".
We've seen companies from all corners of the market get involved. That means traders are trying to squeeze the last fuel from this rally's tank.
That last push may be the one that tips the market over the "Euphoria" stage, which should have us all watching the next month more closely.
We're headed into another earnings season that will kick off the week starting July 17. Just like last quarter, it's all about the expectations.
Low expectations make it easier for the market to rally through July. Higher expectations? Well, that makes it more difficult for companies to impress investors.
Enter the good people at FactSet with this headline.
Last quarter's earnings magic was driven by lowered expectations. More than 75% of the S&P 500 companies beat the market's earnings expectations. That number is huge considering that expectations had been lowered considerably.
Now, the ante is higher as expectations haven't been lowered as much for the upcoming quarter.
What about "AI" though?
Let's face it, AI is a long-term driver of valuation for the market. Right now, the markets have scrambled to pay premiums for the "AI X Factor". I'm not sure that we'll get the same results over the next earnings season.
Why?
President Reagan may have said it best when quoting a Russian proverb... "Doveryai, no proveryai". That translates to "trust but verify".
The market has already trusted the power of AI in paying wild premiums. Now it may be time for some verification.
Bottom line, I'm not as sure the market gets a free ride from lowered expectations and A.I. again. We'll see.
So, with all having been said, where do I see things heading?
Watch for a little pause or hesitation this week. The Fed and latest inflation data are out of the way now and the market is set to trade on its own merit.
A short-term correction to the major indices 20-day moving averages would be a pause that refreshes.
That translates to the SPY shares $427, The Invesco QQQ Trust Series 1 (QQQ) $352, and the iShares Russell 2000 ETF (IWM) $180.
Note that the IWM is just above its 20-day moving average and 200-day moving average. We need these levels to hold over the next week as it would confirm that the "risk-on trade" is technically sound.
At the sector level, I will be focusing on four critical areas. Housing, Regional Banks, Retail, and commercial real estate.
These sectors are critical as they represent the strong (housing) and weak (the other three) sectors of the market. Failure for all means that we're in for a bumpy ride as earnings approach.
I'll break down these sectors over the next few days to give you the insight necessary to navigate this somewhat confusing market.
All things equal, the market's sentiment or psychology is going to play a heavy hand in this market's trends.
As I said, you're in good hands when it comes to that.
We'll talk tomorrow.
The post This is Where the Markets Rally is Heading appeared first on Penny Hawk.
About the Author
Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.