The best week since June. That’s what the U.S. stock market delivered last week, as investors embraced the prospect of falling inflation and a potential deceleration in the Fed’s rate hike cycle.
The S&P 500 Index of large-cap U.S. stocks surged 5.9%. It’s now up 11.6% from its October low and down roughly 17% from its January 3rd high. The Dow Jones Industrial Average rose 4.1%. And the Nasdaq Composite exploded, jumping 8.1%, its best weekly showing since March.
The VIX Index, a measure of implied volatility in the stock market, fell 8.3% to a reading of 22.5—its lowest level since August. Helping the equity rally was a weaker U.S. dollar, which declined nearly 4% for the week.
Falling interest rates helped too. The 10-year U.S. Treasury yield dropped to 3.82% from 4.16% the week before. Bond prices rallied as a result. Intermediate-term Treasuries rose 1.97%, and long-term Treasuries surged 4.1%.
Foreign stocks looked strong as well. The MSCI EAFE Index of developed country stocks surged 8.4%, and the MSCI EM Index of emerging market stocks rose 5.7%.
Real assets were more mixed last week. Real estate did well, rising 6.5%. Commodities, however, fell about 0.5% broadly. Oil dropped 3.2%, corn fell 2.6%, and gold gained 6.4%.
Confirmation – One of the things that we look for when we model stock market risk is this idea of confirmation.
In a nutshell, this means that if we see something changing in the stock market—a turning point or a rally, for example—are we also seeing other indicators confirm that message?
If the answer is yes, we can feel more confident that we’ve uncovered an actual signal. If not, it’s likely just noise.
Last Thursday, the Consumer Price Index for October was released, showing a cooler-than-expected 7.7% increase over last year. The stock market responded enthusiastically, with the S&P 500 Index surging 5.5%—its biggest intraday gain since April 2020. Not to be outdone, the technology-heavy Nasdaq Composite advanced a whopping 7.4%, its sharpest climb since March 2020.
That’s obviously some nice price action to see. However, we want to know if it can be sustained. To answer that, like a detective, we have to start piecing together the evidence, which means looking for indicator confirmation.
So, where are we seeing confirmation?
Relative strength is the one area that stands out at the moment. As the Financials Divergence indicator below shows, the financials sector of the S&P 500 Index is starting to break out relative to the broader S&P 500.
This is significant because the financial sector historically tends to lead the broader market. So, when the financial sector is confirming strength in the broader S&P 500—like it is now—that tends to be a bullish signal for the overall stock market.
So that’s the good news. The bad news, however, is that this is just one bullish component among a sea of primarily neutral or even negative components comprising our primary stock market risk model.
For example, volume and flows still look pretty weak. One of these particular indicators, shown below, is still in a negative zone. This indicator measures volume demand (total volume of advancing stocks) and volume supply (total volume of declining stocks) in the stock market. Historically, the S&P 500 Index has only had positive returns when volume demand outpaces volume supply.
Unfortunately, as the chart shows, this is currently not the case. Seeing this measure turn bullish would go a long way toward confirming a turning point in the stock market.
The bottom line? We are seeing some signs of confirmation among our indicators—like relative strength, for example. This is an encouraging step in the right direction. However, there is still more work to be done in areas like volume and flows before we can say that the environment has truly shifted in favor of equities.
This is intended for informational purposes only and should not be used as the primary basis for an investment decision. Consult an advisor for your personal situation.
Indices mentioned are unmanaged, do not incur fees, and cannot be invested into directly.
Past performance does not guarantee future results.