Uncertainty following last week’s rally

Stock prices accelerated their uptrend on Friday, and the S&P 500 index reached new record high of 4,975.29 following top tech earnings releases and some better-than-expected economic data. My short-term outlook was still neutral because the market seemed overbought and ready for a downward correction. When in doubt, it’s better to stay out of a position than to try to catch a top and open a short position too early. Yesterday, the index retraced most of its Friday’s gains early in the session, and then it rallied back up, closing just 0.32% lower.

Although a downward correction is widely expected, the overall market sentiment remains bullish, and the index may get another chance to reach the 5,000 level. This morning, futures contract indicates that stocks are likely to open virtually flat, still relatively close to their highs. Notably, LLY released its quarterly earnings earlier today, with the stock poised to further extend its yesterday’s nearly 6% rally. In pre-market trading, this stock, with a market capitalization exceeding 600 billion dollars, is up by additional 5.6%.

Quoting yesterday’s analysis, “Last week, upward momentum was fueled by earnings releases and expectations of a more accommodative monetary policy from the Federal Reserve. However, on Wednesday, the Fed's pivot in monetary policy became less obvious, leading to a sell-off in stocks. Stock prices reacted negatively to the release of the Fed's monetary policy and Jerome Powell's press conference. The S&P 500 index sold off to a local low of around 4,845. However, on Thursday and Friday, strong earnings releases and positive monthly jobs data drove prices back up to new records.

Investor sentiment significantly improved last week; the Wednesday’s AAII Investor Sentiment Survey showed that 49.1% of individual investors are bullish. The AAII sentiment is a contrary indicator in the sense that highly bullish readings may suggest excessive complacency and a lack of fear in the market. Conversely, bearish readings are favorable for market upturns.”

Last Tuesday, I wrote that “Despite new highs, it seems that a correction scenario is likely in the near term. (…) caution may be advised, as a correction or consolidation could occur at some point.” The prediction proved correct until Thursday when the market began rallying again. However, today, the same statement remains very true, as the market still appears overbought in the short term. Yesterday’s intraday trading cast some shadow on the short-term bullish outlook.

The S&P 500 is likely to trade sideways this morning. Yesterday, the market entered a consolidation following Thursday’s-Friday’s rally, and today, it may continue to fluctuate. The index remains close to its Friday’s all-time high, as we can see on the daily chart.

VIX still going sideways

The VIX index, also known as the fear gauge, is derived from option prices. While it continues to trade sideways, there have been attempts at a breakout above the 15 level.

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.

Futures contract extends consolidation

Let’s take a look at the hourly chart of the S&P 500 futures contract. On Friday, it was close to the 5,000 level, and yesterday, it backed off a bit. For now, it looks like a consolidation and a flat correction of the uptrend. The nearest important support level remains at 4,940-4,950, and the crucial one is at 4,880-4,900, marked by the recent lows.

Conclusion

Yesterday, the stock market retraced some of its Thursday’s-Friday’s record-breaking rally, and this morning, more uncertainty is expected. For now, it looks like a profit-taking action due to better-than-expected economic data and strong U.S. dollar.

However, in the short term, the possibility of a downward correction cannot be overlooked. A quick glance at the chart reveals that the S&P 500 index has become more volatile recently.

On December 21, I mentioned that “in a short-term the market may see some more uncertainty and volatility”, and indeed, there was a lot of uncertainty following the early-December rally and the breakout of the S&P 500 above the 4,700 level. However, the previous week’s price action left no illusions of a potential medium-term trend reversal. On Tuesday, I noted that “The market is overbought in the short term, but predicting a correction is currently very challenging.”, and it is still proving correct; the Wednesday’s rout was very short-lived and on Thursday and Friday, bulls came back with a vengeance.

For now, my short-term outlook remains neutral.

Here’s the breakdown:

• The S&P 500 is expected to extend a short-term consolidation following last week’s record-breaking rally.

• Currently, it appears to be undergoing a relatively flat correction within the uptrend.

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

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