The stock market, once riding high on a five-month rally, has hit a speed bump, experiencing its third consecutive week of decline. This pullback, coupled with an elevated valuation and excessive optimism, raises questions about the market’s resilience and potential for a rebound.
Triggering Factors
Various factors have contributed to the recent market downtick, including:
- Rising inflation and the Federal Reserve’s tightening stance, leading to higher interest rates
- Geopolitical tensions and their impact on global markets
- Seasonal headwinds typically seen in election years and after strong first quarters
- Overbought conditions and a surge of optimism during the previous rally
Oversold Signals: A Promise of Rebound?
Despite the current setback, several indicators point to a potential bounce in sight:
- The Nasdaq Composite has fallen significantly below its recent peak and below its 100-day moving average.
- Relative strength readings indicate the market is oversold, comparable to previous trading lows.
- Elevated put option volumes and an inverted Volatility Index suggest a tightly coiled market vulnerable to a quick recovery.
Considerations and Market Sentiment
It’s important to acknowledge that extreme selloffs can intensify, but oversold readings often precede liquidations. While market sentiment has grown increasingly cautious, outright fear has yet to set in.
Research reveals that 40% of 5% market pullbacks deepen into 10% corrections. However, dip-buying has been profitable in recent years, as 85% of 5% dips led to new highs within three months.
Market Timing: Echoes of History
Observing the market’s movement down its price chart highlights the pullback’s trajectory through time. The index closed at the same level as March 8, marking the high point of market optimism.
A 10% correction from the S&P 500’s peak would bring it below the 4800 mark, a level tested in 2013 after its first record high in over five years.
Valuation and Concerns
The S&P 500’s forward multiple has decreased from 21 to 20, but this remains above levels typically considered “cheap.” Bond yields have played a role in suppressing market expansion, as cash-rich mega-caps with strong earnings momentum tend to fare better.
Key Economic Indicator Ahead: The PCE Report
Next week’s PCE report will provide valuable insight into inflation and its alignment with the Fed’s target. A less hawkish stance from the Fed could shift market assumptions towards a more optimistic outlook.
Lessons from the Pullback
Amidst the market volatility, several key lessons emerge:
- Excessive optimism and overbought conditions can lead to corrections.
- Oversold readings can signal potential rebounds.
- Timing the market is challenging, but indicators can provide guidance.
- Economic fundamentals and central bank decisions play a crucial role in market trends.
Data sourced from: cnbc.com
