S&P 500: Alarm Bells
3/3 Correction Criteria
Alarm Bells
The S&P 500 closed the week down another 2%, and the Nasdaq fell 3%. This decline puts the S&P 500 5.7% away from its all-time high and the Nasdaq nearly 11% below its peak.
Market conditions worsened significantly on Thursday and Friday— ending in the activation of all three correction criteria for the second time this year. The previous signal on April 10 saw the market decline an additional 4% before stabilizing.
What about the melt-up scenario? This is placed on pause until the observations of bullish character return. The broader market correction criteria in my analysis take priority.
Risk Off Criteria - 3/3
Three indicators in my analysis determine if the market is in a risk-on or risk-off environment. When all three are active— the market is risk-off, and vice versa when they are inactive the market is operating with a risk-off backdrop.
The prior two weeks the risk criteria remained at 2/3, however ending Friday last week, all three criteria are active.
The three criteria are:
The Short Term Trend— price relative to the 20-day exponential moving average
Breadth— the number of stocks making new highs vs new lows across NYSE & Nasdaq markets, middle panel “Net New Highs”
Momentum— measured using the Percentage Price Oscillator, lower panel
Currently, price remains below the short-term trend level (5482), breadth is negative, and momentum is in a downtrend.
The chart below highlights moments when all three corrective criteria are triggered, marked by vertical lines. Reviewing the chart shows that losing the short-term trend, coupled with negative breadth and momentum, has consistently preceded significant market declines. Based on this pattern, I speculate that the index is likely to decline further before this correction is complete.
In the near term, there is a key technical event and level to monitor. The event is a bearish crossover, where the short-term moving average crosses below the medium-term moving average. Observing how price reacts after such a crossover can provide valuable insights into the potential magnitude and duration of the decline. The level to watch is 5250, which marked a previous high in April and later served as a breakout base in June.
Risk On: What About The Melt Up? Small Caps?
Throughout my weekly Sunday notes, I've shared two key measures for determining a risk-on market environment: (1) the absence of the risk-off criteria mentioned above and (2) the participation of modern risk-on equities—specifically, the ARK Innovation ETF (ARKK) and the Russell 2000 ETF (IWM).
As of Friday, the conditions have put the melt-up trade idea on hold. The risk-off criteria are signaling alarms, and small-cap participation was strongly reversed with ARKK declining nearly 10% last week and IWM almost 7%.
ARK Innovation ETF
The ARK Innovation ETF has paused its risk-on character development. Price failed to stay above the critical 45 level last week, and the 50-day moving average offered no support—a trend line that has historically supported the fund during strong uptrends.
I am no longer positioned in ARKK for the melt-up trade. The strategy was straightforward: maintain exposure above 45, exit on any close below 45, and position for a restart. This process would repeat until either a breakout occurred or a deeper correction prevented development. The price closed below 45 on Thursday, ending the second attempt, and with the three risk-off criteria alarming, I am placing this idea on hold for a later time.
IWM - Russell 2000 ETF
The Russell 2000, a more traditional risk-on barometer, failed to maintain its price above the 212 breakout level, which it held for over three weeks. The chart now gives the appearance of a potential failed breakout.
Bond Thoughts
In June the relationship between rate cuts and market bottoms was reviewed— highlighting historical trends showing that markets often bottom after central banks cut rates. My outlook remains consistent: the first cut could trigger the next bear market. The most recent FOMC meeting increased the odds to 67% for a 50 basis point cut in September.
Bond prices and interest rates have an inverse relationship, a breakout in bonds provides a supporting narrative for an interest rate cut— and potentially the start of a larger corrective move in equities.
The chart below is of the iShares 20+ Year Treasury Bond (TLT). There are two visual levels being monitored:
The solid red descending level of resistance,
The 100 level, marking the December 2023 peak
The general rule of thumb I am maintaining into year end is if TLT trades above 100 it is a point to reassess the longer term outlook in equity markets, and spot I am interested to increase bond exposure.
Summary Outlook
Last week's market performance has swiftly shifted the narrative from considering a melt-up trade scenario to now monitoring the potential for a larger corrective move. The risk-off criteria have triggered alarms, and the economic backdrop appears suitable for the first rate cut as early as next month.
My market outlook for index positions remains unchanged:
Bullish: When small-cap categories signal risk-on with ARKK above 52 and IWM above 212.
Bearish: When the three risk-off criteria simultaneously signal.
Like the market, my outlook has quickly shifted to bearish. However, since the three correction criteria only signaled at the end of the week, I have not yet positioned for immediate bearish exposure. If conditions remain poor, I plan to short the index on a rally that stalls at the key moving averages (5425) while the corrective criteria remain active.
Disclaimer: The information in this article is for informational purposes only and should not be considered financial advice or a recommendation for any investment. I am not a financial advisor, and the content is not intended to serve as financial advice. It is solely intended to journal thought, ignite more thought and discussion.