Stocks are set to gap lower to start the week. It is not a big surprise that the market is finally undergoing corrective action after a fast and furious run, but the billion-dollar question is how far it will go. Is this just a reset that will set the stage for another push higher, or is it the failure of a bear market rally that the pessimists have warned us about?
The good news is we don't need to answer that question today, but we do need to increase our vigilance and be ready in case the selling pressure accelerates. The S&P 500 can pull back to 4,160 or so without doing major technical damage, but such a move would cause some pain and there likely will be some rotational action that is going to be harder on sectors such as growth, biotechnology, small-caps and technology.
The thing that is particularly interesting about the market right now is how quickly the narrative is shifting. During the big run off the June lows, the narrative was that the market had already priced in the worst and that it could handle a hawkish Fed. There was increased optimism that the strong labor market would provide enough strength to withstand a series of rate hikes and avoid a recession. The drop in energy and commodity prices also provided hope that inflation had peaked.
Last week the narrative started to become less positive. The Fed has made it clear that it is not likely to pivot to a more dovish stance very quickly, and there is increased debate over whether the unemployment rate needs to increase in order to effectively deal with inflation.
Some bulls contend that there has never been a bear market bounce of this magnitude that did not produce a bottom. We shall see, but we have never had economic conditions similar to this at this stage of the market cycle. I have little confidence that there is a historical precedent for this market.
As I've been discussing, I have raised quite a bit of cash into the recent strength primarily because many stocks I favor have become technically extended and I am not seeing many good entry points. Even after a few days of weakness, it is still going to take more work for better charts to develop.
This is the time for caution. Don't be in a rush to put valuable capital back to work. If you are going to trade, then keep time frames short and don't forget that we are going to be dealing with negative seasonality for a while.