Are stocks overheating?

Stock prices continued their uptrend on Friday, with the S&P 500 gaining 0.54% and breaking above the 5,600 level. The market is once again nearing its July 16 record high of 5,669.67. But will it continue upward? Today, the index is expected to open 0.1% lower as markets await the FOMC rate decision on Wednesday. In the short term, the market appears more and more overbought, making a correction likely at some point.

Last week, the investor sentiment worsened, as shown by AAII Investor Sentiment Survey on Wednesday, which reported that 39.8% of individual investors are bullish, while 31.0% of them are bearish, up from 24.9% last week.

The S&P 500 index is approaching its August local highs, as we can see on the daily chart.

S&P 500: +4% last week

Compared to the previous Friday’s close, the S&P 500 gained 4.02%, retracing nearly all of the prior week’s 4.3% decline.

Last Monday, I wrote “I still think the recent decline is just a downward correction, likely part of a medium-term consolidation that started after the mid-July record high.” This was accurate, and the market could experience more volatility following the Fed's update on Wednesday.

Nasdaq 100: Still relatively Weaker

The technology-focused Nasdaq 100 gained 0.47% on Friday, extending its short-term uptrend. However, it remains relatively weaker, trading well below the local high from August 22 and far beneath the July 10 record high of 20,690.97. This morning, the Nasdaq 100 is expected to open 0.4% lower.

VIX: Continued decline

On the previous Friday, the VIX index, a measure of market fear, reached a local high of 23.76. It was indicating elevated fear among investors. Last Wednesday, the rebound in stocks pushed the VIX lower, and on Friday it closed below 17.

Historically, a dropping VIX indicates less fear in the market, and rising VIX accompanies stock market downturns. However, the lower the VIX, the higher the probability of the market’s downward reversal. Conversely, the higher the VIX, the higher the probability of the market’s upward reversal.

Futures contract: Remaining above 5,600

Let’s take a look at the hourly chart of the S&P 500 futures contract. It continues to trade above the 5,600 level after last week's rebound. The resistance remains between 5,630 and 5,650, marked by the previous consolidation.

Conclusion

The S&P 500 index is likely to open 0.1% lower this morning. The key question is: Is this the beginning of a new uptrend leading to a record high? For now, it seems more like a medium-term consolidation. Investors are waiting for the Fed’s policy update on Wednesday, and in my opinion, profit-taking is likely at some point.

Last Monday I closed my profitable short position, at 5,462. This position, opened on August 20 at 5,626, generated a 164-point gain.

In my Stock Price Forecast for September 2024, I noted that, “the market experienced significant volatility in August, with a roller-coaster ride that included a sell-off to the August 5 local low and a subsequent advance, leading to a consolidation near the record high. (…) sharp reversal suggests more volatility in September. Last month, I wrote that ‘August is beginning on a very bearish note, but the market may find a local bottom at some point.’ The same could be said today, and September will likely not be entirely bearish for stocks.”

For now, my short-term outlook is bearish.

Here’s the breakdown:

• The S&P 500 has broken above the 5,600 level, approaching its mid-July record high.

• Investors are awaiting the FOMC Rate Decision on Wednesday.

• In my opinion, the short-term outlook is bearish.

---

Want free follow-ups to the above article and details not available to 99%+ investors? Sign up to our free newsletter today!