Q3 Market Outlook: More Need for Precision, Short-Term, but Bulls Still in Control

Q3 Market Outlook: More Need for Precision, Short-Term, but Bulls Still in Control

July 06, 2023

After a surprisingly powerful first half for stocks, where do things stand now? Is it time to book profits or is there more room to run in 2023?

The short answer: the market still looks pretty healthy.

That said, things aren’t as obvious as they were in October, when we made our clearest call in years for investors to get long the market, mostly due to shorter-term indicators that are becoming a bit extended.

As the third quarter begins, we will look at both short- and long-term broad market indicators and I’ll provide some thoughts regarding how to approach stocks today. I will also focus on the dollar, bonds and gold to explore whether we can determine where those inter-related asset classes might be going next.


Big Picture Market Status

For a longer-term view of how the market stands, we need slower-moving indicators. From this chartist’s perspective, the Point & Figure Bullish Percent indicator is the best long-term indicator of the markets overall health.

Measuring very simply what percentage of NYSE stocks are in bullish chart formations, this indicator usually ranges between 30% on the low (oversold) side to 70% on the high (overbought).

Despite the big run we’ve seen since the October low, when it sat at an extremely oversold 18%, this indicator is nowhere near overbought levels yet. Today, despite the gains we’ve seen in 2023, the NYSE Bullish Percent only stands at 51% -- midfield. No overbought cause for alarm anywhere in sight:

I’d say the same is true for the what we call the OTC (over-the-counter) Bullish Percent, which measures the tech-heavy NASDAQ, but that would not be totally accurate. While this indicator is also in a bullish trend, which I’ll explain in a moment, it only stands at 37% today:

Yes, the NASDAQ remains closer to oversold territory than overbought, according to the most foundational technical indicator I favor!

Both the NYSE and OTC Bullish Percent gauges are in “bull confirmed” mode, which simply means they are not only in rising columns (X’s), but they have also made a series of higher highs along the way.

Squaring Fundamentals with Technicals

Sometimes, the two branches of stock market analysis don’t seem to square. That’s why I value technical analysis more heavily.

Yes, I understand that the yield curve is deeply inverted´╗┐. I’m also aware that the leading economic indicators have been in decline for over a year. And it’s hard to imagine how rising rates haven’t yet hammered housing prices.

But all of this fundamental information is why I favor technical analysis over fundamental analysis alone, as I described earlier this year. Anyone waiting for many of the common fundamental indicators to line up would have missed this entire rally.

And in my opinion, they’re likely to miss further upside that awaits, as the long-term picture seems to carry only an average amount of risk, at most.

Shorter-Term Backdrop

As markets await the next round of quarterly earnings reports, a short pause in the uptrend is a distinct possibility.

‘Wait a minute,’ you might be thinking, ‘didn’t you just say that the long-term market picture looks surprisingly healthy?’ Yes, but the shorter-term indicators are getting a bit extended. What does this mean? Well, investors with fresh cash to deploy should do so with some caution and selectivity at present, rather than piling in.

Two shorter-term indicators we value are the HiLo, which we featured in that October ‘buy now’ article. The other is the percentage of stocks above their own 10-week moving averages. When these two indicators move in tandem, it gives added short-term confidence.

Where does each stand today? The NYSE HiLo currently rests at 75%, while the NYSE 10-Week is at 68%. Like the longer-term Bullish Percent indicator highlighted above, each is in ‘bull confirmed’ mode.

So what’s the problem? Well, like the longer-term Bullish Percent indicator these shorter-term gauges also tend to live in that 30-70% range. This means that currently, they are both healthy but extended. What’s trickier is that the HiLo and 10-Week can extend well above and below those 30/70 markers, meaning each is only mildly overbought at present.

This means that for now, there are actually no visible cracks in the market’s health from a technical perspective. That said, we’ve been in this rodeo for quite a while and know that reversals down from such levels do occur.

Recently, we blew up the “Sell in May and go away” seasonality that used to be well-founded advice. Yet, while the market has performed well between May and October over the last decade, there are still things we have seen from the summer months in recent years: July has tended to be a strong performer, while August and September are less reliable.

Will we see a little more upside before a pause or a correction? That appears to be an outcome worth watching out for but we will take it as it comes.

Either way, it is reasonable to be on the lookout for either a pullback or some choppy, sideways action as the summer ages. Will such a pullback, which would show up first in the shorter-term indicators, lead to a painful, longer-term pullback or just a small pause the refreshes? Given the fact that longer term indicators are nowhere near overbought conditions, for now I suspect the latter.

Yes, we may finally see stocks take a pause sometime later this summer. However, at this point we suspect that any such correction will allow for the deployment of more capital on the long side.

Summary of Short-Term P&F Indicators:

NYSE HI LO -75 In Bull Correction status from elevated levels. Beware of this reversal down from such an elevated. We would like to see both the HILO and the 10 Week move in tandem giving more confidence in confirming trends. For now, this is a mild short-term warning, nothing more.

NYSE Stocks Above 10 Week Moving Average – 68 Bull Confirmed. Still in a rising column but approaching overbought territory from which reversals down need to be taken more seriously.

OTC HILO – 43 Bull Correction. This means we have seen a reversal into a declining column (O’s), but there’s no confirmation of a short-term downtrend yet, which would be signaled by a break below a prior declining column. Even if such a confirmation did occur, downside risk would be somewhat limited since this reversal is not starting from overbought territory above the 70% level.

OTC Stocks Above their 10 Week Moving Average. – 50 Bull Confirmed. Still healthy and in a rising column of X’s. Although I wrote last month that the market’s rally was not as narrow as some were saying, it is also true that it has not become fully broad – and in our opinion overbought – on the NASDAQ side of the aisle.

S&P 500 Index (SPX)

(A simple P&F chart of the S&P 500 provides some cause for short-term caution, as it rests near the top of its expected trading range. A decline into O’s, along with any reversals in the HiLo or 10-Week, would signal caution, particularly if that pullback were to break below the last column of O’s you can see above).

NASD COMPOSITE (NASD)

(Despite a NASDAQ rally that is less overbought and less broad than its NYSE counterpart, this index is also near the top of its expected trading range, also suggesting a pause could be near).


Bonds, Gold and the Dollar: Where to Next?


Bonds – 10 Year Yield Index (TNX)

Bonds are still waiting on the Fed’s interpretation to the economy’s puzzling trends. Are they done hiking? Rather than guessing, what we can see here is that long-term rates are on the verge of breaking what is called a “triple top” formation. Were that to occur, we could expect a surge higher in rates.

ICE US Dollar Index (DX/Y)

The dollar’s chart is the most difficult to call at present. It is forming a triangle pattern from which a breakout in either direction will be considered meaningful. Fundamentally, if long-term rates were to break higher, it would make sense to expect a surge in dollar strength. Rather than guessing, however, we will monitor the Greenback’s action, then act accordingly.

Gold Continuous (GC/)

Readers know I suggested in early May that a pullback in the yellow metal could be imminent, and gold’s performance since then has indeed been poor. A series of lower lows suggests there is no need to rush purchases at present. And in tandem with the two assets above – rates on the verge of an upside breakout and a U.S. Dollar that could follow higher with them – the bullish fundamental story for gold doesn’t hold much water at present, either. The best thing that could be said for gold is that it is working its way to oversold levels from a technical standpoint.

(Remember: in Point & Figure analysis, numbers in the charts represent months. Looking at the 5 and 6 above, then, it is easy to see how poor gold's performance has been in May and June).

Conclusion

As the third quarter kicks off, we do expect either a pause or a pullback in markets sometime soon. Given the technical health of longer-term indicators, however, we think any such correction will be a pause that refreshes. Any third quarter retrenchment in stocks may present another entry point for investors hoping to deploy capital in the new bull market that began last October.