S&P 500: The Next Breakout

Consolidation setting up the next advance

Image Credit: Midjourney AI - Breakout Bulls Waiting For Green Light

Conditionally Bullish Consolidation

Into the long weekend the markets closed on a mixed note: the S&P 500 edged up by 0.24% for the week, while the Nasdaq dropped by 0.74%, the Russell 2000 remained flat, and the modern small-cap barometer, ARKK, declined by 3.07%.

For the past two weeks—since the market closed on August 14—the risk-off criteria monitored in this newsletter have been absent, during which the S&P 500 has risen by 3.7%. While the absence of risk-off criteria doesn't necessarily signal a shift to risk-on, it serves as a foundational starting point. Since September 14th, the major index has largely traded sideways, consolidating the early August rally amidst a series of significant financial and economic reports. This sideways consolidation maintains a bullish tone, as long as the price stays above the short-term moving average (20-day exponential), suggesting that the market may be setting the stage for the next upward advance.

This week's note, like every first Sunday letter of the month, is free for everyone. To continue receiving detailed updates on the risk-off criteria, a series of trade ideas, and out-of-cycle notes when market signals flip, consider subscribing with monthly or annual options available.

Risk Off Criteria - 0/3

Each week, we begin the market analysis by reviewing the risk-off criteria. These three components define the market's current environment as either risk-on or risk-off. When all criteria are active, they effectively signal significant market risk. Conversely, their absence generally indicates a likelihood of positive market advances. Further analysis of risk-on market segments like small caps helps determine the overall bullishness of the market.

The status of each of the three are summarized on the right side of the chart:

1. The Short Term Trend— price relative to the 20-day exponential moving average

2. Breadth— the number of stocks making new highs vs new lows across NYSE & Nasdaq markets, middle panel “Net New Highs”

3. Momentum— measured using the Percentage Price Oscillator, lower panel

Price closed above the short term moving average (5544), breadth and momentum remained positive throughout the week.

Navigating The Short Term

For the short term, the strategy is to keep it simple. The short-term moving average, one of the three risk-off criteria components, serves as an excellent visual support for the S&P 500 during uptrends.

Minor corrective moves toward this level have historically been beneficial. If the price fails to sustain above this key support, it triggers one of the three risk-off criteria, and subsequent analysis of the other components will clarify the market environment.

The breakout point is well-defined, marked by the intraday all-time high of 5669.

The Small Cap Summary

ARK Innovation ETF

ARKK ended the week above the 50 day moving average (44.42), prior long term advances in this market segment have been well supported by this moving average. The commentary on ARKK has been a bit of a broken record as we have patiently watched the product continue its extended 2+ year consolidation. The critical level remains 52— a breakout above will signal a major shift in character.

As our regular readers know, I am actively working to establish a positive position in ARKK in anticipation of a potential market melt-up, a scenario where I believe small-cap equities will significantly outperform the broader market.

The strategy has been straightforward: go long on ARKK when the ETF closes above 45 and exit the position if it closes below 45. This process is repeated until either a breakout occurs or a deeper correction disrupts the potential for a melt-up scenario. The trade ideas is now preparing for a fourth entry attempt. When I initially shared this strategy in July, I noted, “I expect this initial positioning to experience a few minor setbacks before establishing meaningful trade exposure.”

Setting expectations upfront has alleviated any frustration in establishing this position, as minor setbacks were anticipated.

IWM - Russell 2000 ETF

The Russell 2000 is in week three above 212. Recognizing this level in 2021 acted as significant for the better part of the year, it leaves the thought that breaking out could take equally as long. For me, closing price above 212 remain to be interpreted as bullish and supportive of breakout scenarios across individual small cap equities.

Summary Outlook: The Two Trades

My market outlook for remains consistent:

In the bullish scenario: position overweight long in small cap equities, namely ARKK. Signals for this scenario are the absence of “risk off criteria” in the broader market and a breakout in ARKK and IWM trading above 52 and 212, respectively. The US Small Cap trade idea category through this scenario will gain exposure.

In the bearish scenario: position short the S&P 500, and long bonds. Signals for this scenario is when all three risk-off criteria are simultaneously triggered— and long bonds becomes favored when TLT (iShares 20+ Year Treasury Bond ETF) trades above 100.

Ending last week TLT put a pause on its progression towards 100.

Trade Ideas

All three category trade ideas: US Small Cap Equities, Outside US Equities, and The Gold Trade were updated in last week’s letter. The updates remain relevant into the coming week— details here.

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.