Following a furious run over the last several weeks, stocks are set to rest. The last two weeks of August are peak vacation season on Wall Street, and volume typically is very light. With many stocks now overbought, it is an ideal setup for some consolidation.
The most important issue is whether strong support starts to develop. When stocks go straight up as they have recently, support tends to be weak, but the S&P 500 does have a key level at 4,175, which will be the first level that will matter to the downside.
The notable characteristic of the recent market action is that it was primarily driven by liquidity and poor positioning. There has been hope that inflation is slowing and that the economy is strong enough to withstand a hawkish Fed and won't slow significantly, but there really has not been a big shift in the macroeconomic environment. Bond yields have been rising, and while inflation readings are soft they are still at the highest levels in 40 years.
The biggest positive right now continues to be poor positioning. This rally was so powerful because no one really expected it to be so strong. The longer it continued, the more anxiety there was that it was a significant market shift and not just an energetic bear market rally.
There are still quite a few bears who believe that the lows will be tested, but it will need to be extremely ugly before that occurs. By the time those lows come into play, we will be wallowing in doom and gloom.
I've been raising cash into the recent strength, and my game plan is to play strong defense and make sure I hold on to recent gains. I'll keep looking for new entries, but my main focus is on repositioning for potential volatility as we are now entering the weakest time of the year seasonally. Many charts are looking much better, but it is not necessary to rush and chase them. There will be volatility that offers us some better entry points.
We have a little softness to start the week, but dip buyers often show up on Monday morning and we will see how much conviction they have.