High potential for a short termed correction in the coming weeks

The S&P 500 (along with most world indices) had a marvelous finish to the year. The trend remains as strong as ever, but I’m seeing enough evidence to suggest that now’s the time to start looking for  a pullback. Unless we witness a break in trend, we should anticipate using such a pullback to add new positions if we have cash, or do some swapping of stocks and sectors into those with better potential. Today, we’ll look at the chart of the SPX and note my reasoning behind the potential for a pullback. Then we’ll briefly touch on some thoughts as to what we should be expecting in the markets, and how to best position our portfolios given those thoughts.

To start, here’s the SPX chart going back to the start of the uptrend after the COVID crash in 2020. Note the wider price channel (bigger swings), followed by the tighter price channel (smaller swings) of late. The swings from May 2020 to may 2021 were often in the range of 10%- as indicated with my % retracement measurements. Since May of 2021, the swings have been about half of that. Right now, we are at the top of the current price channel. A swing to the bottom of the channel might project a correction of about 5.5%- as I’ve indicated on the chart. That’s around 4600-ish. This is a daily chart, so the stochastics and RSI oscillators are more sensitive to small overbought/oversold signals. Stochastics suggests a near termed overbought level. RSI is not overbought. However, you’ll note its divergence against the greater trend is bearish.

Seasonal trends also suggest the potential for a correction in January. Despite the fact that we’re in the “best 6 months” for the market, we can get nasty swings in January and February. The chart below from Equity Clock has my notations illustrating seasonal weakness in mid January, followed by an uptick, and then a second period of weakness from late February – mid-March. This can followed by a period of uber-outperformance leading into the flat May to October tendencies. So, the seasonal tendencies for late January might agree with my observations regarding the market being near the top of the price channel – noted above.

 

Overweight the overlooked

Some analysts suggest that valuations can compress during the bull market’s mid-cycle. Morgan Stanley notes (as have I on this blog) – the 15 largest companies on the S&P 500 represent 40% of  its valuation. And its been those stocks that have kept the index pushing ahead. The problem with that, of course, is that the valuations of these select stocks are getting ahead of themselves. Specifically, if you review the very largest 7 of these top holdings (AAPL, MSFT, TSLA, GOOG & GOOGL, NVDA FB) you will note that they are all in one sector – technology. And they ain’t cheap by historic standards. Not to mention that rising rates are not so great for these stocks.

Given the parabolic angle of the SPX, and knowing that a handful of high valuation rate-sensitive stocks have driven the index to that angle, it might be wise to consider avoiding too much exposure to the above names.  We might instead overweight overlooked sectors and stocks in our portfolios. The chart below, which I have posted before, shows us just how steeply angled the angel of ascent is right now. Every time this happens, you get a significant correction or crash. But, it ain’t over until the fat lady sings (as sportscaster Ralph Carpenter famously said). As I’ve noted before, a key sign of the “big one” coming has been a defined peak and sharp hook by my mega long termed ROC (60-month average) shows us. We are not there yet.

While these are not specific recommendations, I might offer some hunting grounds when looking for rotational candidates. For example, international markets, with a particular focus on Emerging Markets, have been in the doghouse. This includes China and Brazil (we hold a Brazil ETF). You already know that I like cyclicals (commodities) given ValueTrend’s big-picture inflation outlook. We also like small caps here. Mid caps might also provide some hunting grounds for your portfolio. These are areas that have not performed along with the nifty-15. And that’s why they might be the next sectors to move.

Important announcement

I’m happy to announce that my Technical Analysis Course will be up and running in a few days. Blog readers will receive a limited time discount that will expire in February to buy the course. Details to come later this week.

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5 Comments

  • Hi Keith – thanks for all the work you do! I’m worried as well about the fiscal health of Canada as well but it appears that every developed country in the world has adopted the notion of being the prettiest house on the ugliest block. Feels like if there is a sovereign debt crisis approaching, that Europe would be the first to fall given that the ECB’s Chrstine Legarde (aka Madame Inflation) has already stated that she will not raise rates until at least 2024. Maybe Turkey is the first contagion spot to the fall – followed by Spain, Italy, France etc. Who knows if it will force long term yields everywhere to rise….

    Regarding Chinese stocks, it seems like this political tension between US and China is real over the Taiwan dispute. Would you still own Chinese stocks or too risky at this point for exposure?

    If yes – what kind of risk premium would you apply for an entry point (i.e. an extra 10% buffer cushion)?
    Seems like it would require a larger discount rate given the delisting possibility.

    Reply
  • Thanks Keith for continuing to post blogs. I get comfort from your information as well as insight from your analysis. I passed on your year end rant to many friends and family as I found it enlightning, especially when you used data from the provided links.
    I have a suggestion for a future blog. It’s been awhile since I can spot any commentary/analysis on the “Utilities” sector (ie AQN/EMA/FTS/NPI). some of these names were hammered in 2021 and it is unclear to me why. Some “fundamental analysts” are suggesting utilities could be a good sector for 2022. What are your thoughts?
    Maybe you could incorporate in that blog “pipelines” which utilities and pipelines, both sectors with dividends being attractive generally to conservative retiree investors.
    Thanks for considering this topic.

    Reply
    • Thanks Daddyo
      Always very interested in hearing ideas that will appeal to a broad spectrum of my readers–this is a topic I have covered in the past (utilities – I noted rising rates spank them)–but I have not done a refresh ion a while. So I will do that, and throw the pipes in with them.
      Good input–thx

      Reply
    • Needs to hold 4600 to stay in the channel–if that breaks, look to 4400 as support. Giving it this week to see how it plays before stepping in. We raised a bit of cash early last week right when I made the call on the blog. Following my own advice!

      Reply

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