According to Bank of America, bearish signals are beginning to gather in the stock market after the S&P 500 rally.
The bank highlighted various technical signals that have yet to confirm the stocks' breakout.
“The Dow Theory has yet to confirm a primary bull market beginning in late 2022,” Bank of America said.
The S&P 500's recent breakout to new 52-week highs has yet to be confirmed by various technical signals, meaning tactical bearish sentiment could be brewing in the stock market.
Bank of America has highlighted some risky signals that investors should watch for a hint of a potential sell-off in stock markets, according to a note on Tuesday. Signals are in limbo as they are yet to confirm a fresh bull market in stocks or reveal a bearish reading that would suggest a pullback is imminent.
These are the stock market signals to watch to better understand whether the stock rally will continue in the second half of the year or give way to a sell-off, according to BofA.
1. Confirmation of the Dow Theory.
This 100+ year old indicator flashes when the Dow Jones Industrials and Transportation Averages break out simultaneously, confirming each other's trends. It is thought that when the economy is doing well and consumers are buying goods, transportation stocks should do well too, since they are responsible for moving those goods.
“The Dow Industrials and Dow Transports confirmed the US stock market's tactical rebound from March, but the Dow Theory has yet to confirm a primary bull market from late 2022. The Dow Industrials needs to break the 11/30/2022 peak at 34,590” while the Dow Transports needs to break the 2/2/2023 peak at 15,641 to confirm a bull market. Until then, the risk of a split US stock market remains,” said Stephen Suttmeier, technical strategist at BofA.
The Dow Industrials average is currently 33,844 while the Dow Transports average is 15,163.
2. Negative divergence in latitude signal.
Technical analysts like to see confirmation between signals when the stock market breaks out, particularly in breadth measurements that measure the underlying involvement of individual stocks in an ongoing rally.
Looking at the NYSE Composite Index and its corresponding NYSE forward-down line, Suttmeier noted negative divergence as the former recently made a higher high and the latter recently made a lower high. For this tactical bearish signal to dissipate, the NYSE forward-down line would need to make a series of higher highs to confirm the NYSE Composite index's upside.
“A higher low on the NYSE stocks Advance Decline (AD) line compared to a lower NYSE Comp (NYA) low provided a bullish divergence for the December 2022 to March 2023 market breadth. This key measure of market breadth however, has not been confirmed. “The recovery from the March low creates a tactical bearish divergence for US equities,” Suttmeier said.
3. High yield spreads have not confirmed their recovery.
When markets worry about an imminent sell-off, high-yield bond spreads tend to lead, warning investors about the risk of heightened volatility from a collapse. The US high yield options-adjusted spread index is currently in no man's land and needs to further collapse to confirm the recent equity market rally. That hasn't happened yet.
“Adjusted spread for US high yield options [is benign] however, has not confirmed the year-to-date rally. The corporate BAA to 10-year Treasury spread has narrowed below 2.0 which is positive. While the options-adjusted spread (OAS) for US high yield has not widened to indicate risk-off credit stress, it has not yet confirmed the SPX's YTD highs. “We see this divergence as a risk,” Suttmeier said.
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