A Pullback, Before an Opportunity

Situational Awareness:

• Stock-Picker’s Market: If you block out macro doomsayers and actually observe the stock market, it is clearly in an uptrend. A correction just occurred in 2022 and now we have Artificial Intelligence as a new growth catalyst, which is showing the early signs of being a game-changer. Companies that adopt AI could benefit from margin expansion for years to come. However the Fed is not in Dovish mode and is not flooding the market with liquidity, thus this is not a market environment where everything goes up. This is a selective stock-picker’s market.

• Time for a Breather: The S&P 500 is a bit extended and is currently in a pullback. Margin debt is at a relative low point and is starting to increase, which makes heavy waterfall declines unlikely.

  

  For SPY, I expect a healthy and orderly pullback to the 21 EMA at around $429 or the 50 SMA at around $418. Strong support could also come at the August 2022 high at $425. In a more dire case, the SPY could hit the lower Bollinger Band at $413, which also aligns with the Ichimoku Cloud. With all the previously scared investors waiting on the sidelines to buy, my guess is that a more shallow pullback is in store. Alternatively, we could correct with time.

  

• Rotations: Last week all sectors pulled back, but defensive sectors outperformed offensive sectors. This is typical in a pullback.

• Commitment of Traders Report: The latest COT report shows that Asset Managers (blue line below) have been accumulating long positions in the S&P 500. Hedge Funds (green line below) have been exiting their short positions, and Dealers (market makers) have been accumulating short positions. Dealers are typically short-term holders, thus I expect them to cover their short positions at a profit as the market dips lower. The buy-in by Asset Managers, who are longer term holders, is a healthy dynamic.

• Sentiment: Sentiment indicators are warning that the pullback could possibly be deeper or longer in time. The Smart Money/Dumb Money Confidence Indicator shows that Dumb Money bought into the recent rally and is now selling. Smart Money sold during the recent rally and is now looking to buy at lower levels. This indicator look like it is at the beginning of a trend, thus its possible that the pullback has a way to go.

The Fear and Greed Model hit the extreme greed area and is now heading down. It could take some time for it to get back to the 60 level, which would continue the trend of higher lows that started in October 2022.

• Breadth: The Bullish Percent of SPX Stocks breadth indicator shows an overbought reading. Historically, it tends to find its way back to oversold, however it can also stay overbought for quite some time.

Cycles:

According to the Stock Traders Almanac, the end of June pullback is statistically a setup for the upcoming 4th of July Rally. Although this is not guaranteed, my cycles are supporting this thesis.

For the S&P 500 the Cycles Composite, Seasonal Cycle and Decennial Cycle are all pointing to a short-term bottom between 6/26 to 6/30. This could be a tradable bottom until around 7/14.

The Nasdaq 100 shows a similar pattern for the summer rally.

The Russell 2000 could be weaker and may not participate in a possible summer rally according to the Cycles Composite below. Remember that there is no guarantee that cycles will be correct.

Trend-Following: Here are some stocks that are showing relative strength during this pullback. Note that I have positions in some of these stocks.

UBER seems to be setting up a breakout. It is above all moving averages and seems unscathed during this pullback.

FTNT pulled back to the 21 EMA and bounced on heavy buying volume.

META continues higher and even hit new highs during the recent market pullback. This is a display of robust relative strength.

Despite the real estate woes that is spoken about in the media, PHM continued to new highs.

ADBE pulled back to the 10 EMA and found buyers.

I have stop-loss orders on all positions, so if the market drops hard, my risk is limited. Please manage your own risk and best of luck making money in the market.

Conclusion: I believe that a shallow pullback will occur in time for a 4th of July rally. Overbought sentiment and breadth conditions will have to reverse eventually, however this could occur from July to October. I personally continue to find tradable opportunities in stocks with relative strength but use proper risk management in case I am wrong.

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