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Stock bulls retraced over half of Friday's plunge, but does it count as a reversal? When I look at the volume, the weekly chart, and the credit markets, I have my doubts. Or will the Powell & Mnuchin testimony and Chicago PMIs ride to the rescue, and provide a catalyst to reignite the bullish spirits? And will Thursday's non-farm payrolls surprise to the upside, as they did a month ago?

The Fed is contracting its balance sheet for a second week in the row, and unless they publicly open the spigots (or credibly signal they're about to do so), stocks look set to struggle in the short run. With the corona second wave fevers rising, will stocks ride unscathed through the rough patch ahead courtesy of more policy actions and all the money sitting on the sidelines being deployed? That's a recipe for quite some volatility regardless of whether Trump later on turns tough on China or not, if you ask me.

S&P 500 in the Medium- and Short-Run

I'll start with the daily chart perspective (charts courtesy of http://stockcharts.com ):

Monday's overnight trading opened with a bearish gap, which the bulls have closed still during the premarket session. Yet at the start of the U.S. trading, stocks again tumbled to the Asian opening lows. The bulls again countered, and repelled another selling wave just before the closing bell.

These were the overriding narratives battling it out earlier yesterday:

(...) On one hand, we have these bearish factors and strengthening corona fears (risks of renewed lockdowns or disruptions to economic activity in general), on the other the uncertain effects of Q2 window dressing and generally rather positive seasonality going into Independence Day.

Given the prominence of each of the above factors, I see the bearish side as the one favored by the odds.

Couple that with this week's turbulences, and the potential for disappointments is high. That is, the downside risks appear disproportionate at this moment, relative to the upside.

That's certainly the message the daily volume is sending. Are the bulls strong enough to make up for yesterday's suspiciously low volume? Should they be earnest about this reversal, they better step in fast - and at higher prices as well, so as not to make yesterday a bull leg in a sideways-to-down trading range.

Before Monday's closing bell, I expressed my reservations in yesterday's intraday Stock Trading Alert. The quoted text is unchanged from yesterday's moment of publishing (12:11 PM EST), and the charts now feature the closing prices:

(...) While stocks recovered from their opening dive below the 200-day moving average, let's do a quick check and put the move into perspectives.

That's this week's chart in progress, putting today's modest upswing into perspective. While the downside risks remains (I would highlight tomorrow's Powell testimony, Wednesday's ADP non-farm employment change, and especially Thursday's non-farm employment change - a cautious tone on corona recovery by Powell, or revealing the disconnect between the real economy and stocks by either of the remaining ones), the bulls haven't turned the tide yet - and the slowly but surely mounting corona fears on the ground aren't on their side.

Credit market's key representative is lagging behind also today - and actually the moment it stopped declining, coincided with the intraday stock upswing. How sustainable is that unless junk corporate bonds turn around?

Both of these points remain valid also today. Stock bulls haven't made any progress as the S&P 500 futures keep trading at around yesterday's closing prices, and junk corporate bonds during the remainder of the regular session dived again while stocks mostly rallied.

That increases the non-confirmation between the two - such a conclusion seems foregone. But let's do the heavy lifting and inspect the credit markets thoroughly next.

The Credit Markets' Point of View

High yield corporate bonds (HYG ETF) keep trading below the Wednesday and Thursday intraday lows, and the bears kept the reins throughout yesterday's session too. The longer this lasts, the more dicey for the stock bulls.

But the investment grade corporate bonds to the longer-term Treasuries (LQD:IEI) ratio is already turning up, unlike the high yield corporate bonds to short-term Treasuries one (HYG:SHY). But does a two-day stabilization followed by a one-day upswing qualify as a turnaround?

Does it have the power and momentum characteristics of the mid-May plunge that came to a halt earlier than the one in HYG:SHY? Or, is it sending a signal of false strength along the lines of the early June S&P 500 plunge and subsequent recovery? Please note the bearish divergence HYG:SHY made then - while LQD:IEI powered higher, HYG:SHY made a lower high. I take that as a vote of no confidence.

The plain comparison between high yield to investment grade corporate bonds (HYG:LQD) also points to waning risk appetite. This is even more concerning when you look at the below chart.

Yesterday's S&P 500 bump looks like Thursday's one - but at least on that day, it was accompanied by higher values in the ratio. With the HYG:SHY yesterday plunging without end in sight, Monday's stock upswing becomes even more suspicious.

Yes, Treasuries are rallying, both the very short-term ones (SHY ETF) and 3-7 year ones (IEI ETF), unlike the riskier corporate bonds (it's only the LQD ETF that actually rose yesterday). I read that as a desire to park money and preference for corporate quality in times of elevated uncertainty and risks to the downside that make you think of summer 1968 as an idyll.

Or are stocks refusing to take a cue from HYG:SHY setting them up both for an explosive upside move as in the latter half of May? Unless the ratio rallies strongly in the nearest sessions, I'll continue to stick to these yesterday-written lines:

(...) We might be at the doorstep of a challenge to the bull market assessment. The key supports to hold are the 200-day moving average (3020, and if you take the 50-week moving average, then 3010), the 61.8% Fibonacci retracement (2940) and the 50% Fibonacci retracement (2790) on the daily chart.

As I wrote on Friday, the corona recovery path & renewed fears of stifled economic activity, and election uncertainties, make for rougher trading over the summer. The elevated volatility surely reflects the potential for both upside and downside moves that can frustrate the bulls and bears alike - unless the Fed or Congress throw in their more than their two cents.

From the Readers' Mailbag

Q: Today's trading shows IWM is leading the market and beaten down stocks are now rising dramatically once again while SPX and NDX stocks are lagging. It looks like sector rotation is going on. SPX and NDX stocks went up too much and investors are finding value in IWM stocks. This could be a sign that market is preparing to go down again just like at the last peak. But then IWM may lead the market to keep SPX and NDX from breaking down further and market may go sideways. $4T on the side line has to go somewhere and this may keep the market afloat. HYG went down while SPX went up today which is a negative which means risk-off sentiment is intact. This conflicts with IWM rally. So, I am not sure what to make of this. How do you see this?

A: Let's start with the situation in the now.

They say that one swallow doesn't make a summer. While on respectable volume, the Russell 2000 (IWM ETF) indeed outperformed the S&P 500 - but can it be said that we're on a doorstep of smallcaps leading higher? I don't think so, and as the corona fears intensify, smallcaps will be as vulnerable as consumer discretionaries (XLY ETF) to any curtailment of economic activity - voluntary or not.

Let's examine the nearest historic parallel, which is the April-May consolidation. Back then, smallcaps broke down below the previous lows in a deceptive show of weakness. Is such a move unfolding currently? Not really. Applying the laws of logic, could it be that they're showing fake strength now? That's possible but far from certain. A more plausible explanation to me is their sideways consolidation while both indices remain under pressure and looking for short-term direction.

I ascribe more meaning to the credit markets' behavior - and their current challenges coupled with the fundamental outlook, make short-term downside in stocks more appropriate to the gloomier and gloomier headlines than not.

What would make me lean more bearish in the IWM interpretation? Should I see profit distribution in smallcaps while the S&P 500 (propped by its handful of heavyweight stocks) still marches higher, that would be it - because eventually, S&P 500 would roll over to the downside as well.

But we're not seeing smallcaps rolling over. Once they do, I can take away the more probable sideways consolidation hypothesis.

At the same time, I think that the smallcaps getting challenged soon is more probable than not. Take it as upping the ante on the current uncertainties, and interpreting them bearishly in the market place. Are yields rising? No, Treasury prices are rising, which questions the accuracy of stock market's interpretation of the recovery and its veracity.

Put/call ratio is again heading lower towards the more complacent readings. Advance-decline volume on NYSE is again deteriorating. The spread between junk and investment grade bonds is on the rise. All of these make for a volatile cocktail that is apt to ambush the bulls with or without an easily noticeable catalyst, and not too far down the road I think.

Summary

Summing up, Monday's upswing probably wasn't the game changer the bulls have been looking for. Low volume, weakening credit markets, plunging Treasury yields are stronger arguments than yesterday's improvement in the S&P 500 advance-decline line or Russell 2000 daily outperformance. The weekly chart's perspective remains little changed as well, and significant short-term risks persist amid the choppy trading (now with a downside bias). The medium-term examination keeps favoring the bears - just as the Fed on pause. Should the market get spooked by corona even more, that would be a cherry on the cake for the bears.

If you enjoyed the above analysis and would like to receive daily premium follow-ups, I encourage you to sign up for my Stock Trading Alerts to also benefit from the trading action described - the moment it happens. The full analysis includes more details about current positions and levels to watch before deciding to open any new ones or where to close existing ones.

Thank you.

Monica Kingsley
Stock Trading Strategist
Sunshine Profits: Analysis. Care. Profits.

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Friday's overnight gains evaporated faster than you could say Jack Robinson, and not much bottom fishing came later that day. Is the tide in stocks turning - or has it turned already? With Thursday's financial news-driven gains reversed in a flash, it's tempting to say so - especially when coupled with the other signs I see in the charts.

In short, more downside appears likely, confirming what I said in Friday's analysis. A quick quote: "Despite the generally positive S&P 500 performance during the runups to Independence Day, the new Fed rules might not have saved the day yet. Trading remains choppy, corona cases just made a new U.S. daily high, and the elections are getting closer."

Will the market agree?

S&P 500 in the Medium- and Short-Run

I'll start today's flagship Stock Trading Alert with the weekly chart perspective (charts courtesy of http://stockcharts.com ):

The weekly candle's opening and closing prices were practically the same going into Friday's session - but that day changed a lot as you can see. Within Friday's analysis, I mentioned the tellingly long upper knots in the two prior weeks, pointing out that a daily downswing would increase the chances of seeing a reversal.

That's what is happening, and I carried on with these observations still on Friday:

(...) Just as the March volume examination showed heavy accumulation, and stock bears unable to reassert themselves right next, last weeks' trading smacks of distribution, of selling into strength. Yes, that's the result of the bulls being unable to stage a comeback this week (so far - we'll soon learn, but the odds favor a downside move).

The thorn in the bears' side is that prices are still trading above the 50-week moving average (roughly corresponding to the 200-day moving average on the daily chart, at 3010 and 3020). Breaking below this support would likely lead to accelerated selling, but we're having none of this so far.

What about the bullish side of the argument? It's about moving prices back into the rising black trend channel - again, we aren't seeing any of this.

The weekly indicators are looking fairly extended, which wouldn't be an issue - but the weakening uptrend in CCI or the RSI continuously unable to overcome its neutral readings, is.

So, these are the reasons why I think yesterday's financial sector news isn't a real game changer, and why I see persisting risks to the downside. True, they might not materialize in the very short run, but the reward potential is higher for the bears here, the longer the above issues persist.

We have seen the daily downswing indeed materialize, and it brought the S&P 500 right to the 50-week moving average (and a tad below the 200-day moving average on the daily chart). These levels were pierced.

The support withstood Friday's selling pressure, but remains in a precarious position - I am unconvinced by the little intraday bounces as the bulls really could have stepped up to the plate some more. This can't be even called a dead cat bounce (or a toned-down base-building), raising questions about the bulls' strength in the now.

Thursday's gains turned history, prices closed below that day's intraday lows, and it happened on really high volume. The Wednesday-discussed fleeting stabilization of daily indicators in the end proved temporary indeed, and the bear raid I discussed, wildly succeeded. The daily close so near the intraday lows makes follow through selling on Monday likely.

On one hand, we have these bearish factors and strengthening corona fears (risks of renewed lockdowns or disruptions to economic activity in general), on the other the uncertain effects of Q2 window dressing and generally rather positive seasonality going into Independence Day.

Given the prominence of each of the above factors, I see the bearish side as the one favored by the odds - do the credit markets agree?

The Credit Markets' Point of View

High yield corporate bonds (HYG ETF) broke below the Wednesday and Thursday intraday lows in the end, and the daily indicators don't rule out more deterioration. Not good for the stock bulls.

But the investment grade corporate bonds to the longer-term Treasuries (LQD:IEI) ratio is holding up better than the high yield corporate bonds to short-term Treasuries one (HYG:SHY). But do two days qualify as a turnaround?

I don't think so, and the below chart tells you why.

High yield corporate bonds to corporate bonds (PHB:$DJCB) ratio has been doing badly recently, and challenges the rising support line made by the recent local lows. The appetite for more risk in the corporate bonds arena seems disappearing, which doesn't bode well for the stock bulls.

Just take a look at how the Q1 strength in the S&P 500 vs. the weakness in the ratio turned out over the coming weeks. We might be at the doorstep of a challenge to the bull market assessment. The key supports to hold are the 200-day moving average (3020, and if you take the 50-week moving average, then 3010), the 61.8% Fibonacci retracement (2940) and the 50% Fibonacci retracement (2790) on the daily chart.

The caption says it all. It's about direction, and both metrics appear ready to go down some more.

Let's quote these Friday's thoughts:

(...) I still stand by the call for rougher trading over the summer. Look, elections are drawing nearer, the polls are showing... whatever - what would happen once the markets start discounting the prospects of Biden presidency more? Markets hate uncertainty, and the Trump years brought us many pro-business policies. Will they continue? What new ones would take their place?

As summer progresses, that could influence stocks more than corona / lockdown fears. The markets would tell us as we go. As I showed you on the weekly chart, the risks are skewed more to the downside in the short- and medium-term.

Volatility appears not really willing to decline from current levels much, which supports the notion of rougher waters ahead. I don't think it would stay this low in July or August.

The market breadth indicators highlight the shifting sands. The advance-decline line hasn't surpassed its mid-June highs - and on a weekly basis, it's challenging its late-April bottom. The bullish percent index also reveals the mounting troubles for the bulls.

Let's move next to the sectoral analysis.

Key S&P 500 Sectors in Focus

Technology (XLK ETF) has stalled recently, and I wouldn't take Friday's downswing on high volume as a sign of accumulation just yet. What concerns me, is that this has been the start performer of the move higher off the March lows - which implies that much of the rest has been lagging behind.

Healthcare (XLV ETF) was the second sectoral heavyweight engine of growth, and it has already made a lower high (unlike the tech, which made a higher high). That's concerning for the stock bulls, because whenever the generals are among the last to hold ground while the rest shows weakness, it's time to put one's guard up.

The veracity in erasing Thursday's news-driven gains in the financials (XLF ETF), is concerning.

Consumer discretionaries (XLY ETF) approximate the healthcare performance, but how resilient will the sector be once lockdown fears rear their truly ugly head?

Among the defensive sectors, both utilities (XLU ETF) and consumer staples (XLP ETF) took it on the chin, and are approaching their mid-May lows. While that makes both leading ratios (XLF:XLU and XLY:XLP) look relatively healthy, don't be taken in - all of these sectors are sinking currently. The only bullish interpretation possible is that the growth sectors are holding up better than the defensive ones, which would point to rotation into growth plays.

Within the stealth bull market trio, let's start with energy (XLE ETF). Given the relative stability of oil prices in recent weeks (that's an understatement as they've been slowly marching higher actually), one would expect a stronger sectoral performance - but remember that the US shale companies are under serious pressure as both Saudi Arabia and Russia price war moves have inflicted pain upon the sector.

In April, the nearest futures contract prices went even negative as so much demand has come offline. But I stand by my call for higher oil prices in Q3 and Q4 especially - just take a look at the June 22 From the Readers' Mailbag section - I talk gold there as well.

Okay, it's the materials' (XLB ETF) turn now. They're holding up relatively better, which reflects the rising inflation expectations (I cover these in the course of answering the gold question in the June 22 Stock Trading Alert).

Despite the encouraging manufacturing activity data, industrials (XLI ETF) are weaker than the materials. Taken together with energy and materials, the stealth bull market trio isn't really helping the S&P 500 move higher, which serves as a red flag.

From the Readers' Mailbag

Q: I read an article on seeking alpha predicting upward movement of Russell 2000 in the 3rd quarter, suggesting buying the IWM and staying long. What's your take on this Monica?

A: Let's start with the situation in the now.

The Russell 2000 (IWM ETF) is still acting weak, with the caption again saying it all. The prospects for it to catch up over Q2 are limited in my opinion. Once we have the election uncertainty removed, the prospects for smallcaps get better. But we might be facing corona and flu panic in autumn as well, which wouldn't really help the sector.

So, I ask - is it really a good time to buy now?

Summary

Summing up, Friday's session raised the specter of more selling over the coming weeks, and justifiably so. Credit market metrics have weakened, market breadth deteriorated, and volatility is far from tamed. The weekly chart is sending ominous signals while the Russell 2000 continues to underperform. Among the sectors, technology can't save the day.

Significant short-term risks persist amid the choppy trading (now with a downside bias) characterizing last two weeks. The medium-term examination favors the bears now. Should the market get spooked by corona even more down the road, that would be a cherry on the cake for the bears.

As the saying goes, you're on the right track with stock bulls - but stay there long enough, and you get run over - and the S&P 500 setup these days is precarious.

If you enjoyed the above analysis and would like to receive daily premium follow-ups, I encourage you to sign up for my Stock Trading Alerts to also benefit from the trading action described - the moment it happens. The full analysis includes more details about current positions and levels to watch before deciding to open any new ones or where to close existing ones.

Thank you.

Monica Kingsley
Stock Trading Strategist
Sunshine Profits: Analysis. Care. Profits.

• Read more

Available to premium subscribers only.

• Read more