The S&P 500 (NYSE: SPY) bottomed about one month ago on March 23. Since then, the rally has been spectacular. One of the most debated questions on everyone's mind is whether or not that was the bottom. Of course, only time will reveal the real answer, and a lot depends on variables like the virus' spread being controlled, policymaker's actions, and the public's willingness to engage in normal activities.
However, in the short-term, the stock market's advance does seem to be losing steam. Key sectors are threatening to undercut their lows, several notable divergences are developing, and market breadth is flagging. Short-term oriented traders should consider taking tactical shorts against recent highs, while investors should be patient and not chase stocks here given overbought levels in the market.
Weakness in Key Sectors
One feature of previous major capitulation lows in this bull market was strong recoveries in the weakest stocks. In part, it was due to massive liquidity entering the market lifting all boats with the most oversold and shorted stocks seeing the biggest gains even if fundamentals remained poor. Typically, this marked a moment in which the worst had been priced in for these stocks, so there were rallies even on bad news.
So far, this is not happening with the most affected stocks like retail, restaurants, airlines, commercial REITs, and hotel stocks. While the broader market advances relentlessly, these stock have been mostly range-bound and in recent weeks been moving lower. It's one major difference between previous inflection points and the current low.
Notable Divergences
Another worrisome development is notable divergences between stocks and other asset classes which increase the likelihood that this strength is being used for distribution. Examples include high-yield bonds weakening in the past couple of weeks and failing to confirm the broader market's highs. Additionally, key commodities connected to the broader economy like copper and oil are failing to meaningfully rally despite hitting extreme, oversold levels.
Cyclical stocks have also been underperforming for most of this rally, and this has only intensified in recent days. Cyclical stocks outperforming is another feature of major lows, and this is absent at the moment. Market breadth was also strong in the initial stages of the rally but has been making lower highs as the broader market made higher highs. This is another sign of weakening participation. Multimonth market rallies feature expanding participation, while shorter-lived oversold bounces tend to feature weakening breadth and roll-over at some point.
Conclusion
The stock market has reached overbought levels on a short-term timeframe. So far, market behavior is more consistent with an oversold bounce rather than a durable rally that will keep relentlessly advancing. Traders should prepare for another bout of selling.