After one of the fastest rallies in years, the stock market is now overbought and due for a pull-back. But whether or not we get that pull-back now or in January will depend upon how bullish market investors remain. While the overbought Magnificent Seven stocks have already started to pull back, a transition from mega-cap stocks into the broader market might keep index valuations high, even as the most overbought stocks in the market pull back. Regardless of what the overall market indices do, one thing is clear: this is now a stock-pickers market. I gave my list of the best stocks to buy in Sunday night’s video here: https://www.youtube.com/watch?v=KmfQDpNvQ7c&list=UULFxFRGG-_23Kqxe0YexDc1eg.
Last Week Recap
The stock market rallied last week after a flurry of better than expected news. Although inflation data came in slightly worse than expected, it still showed a significant decline in inflation. And Thursday’s surprise retail data showed a 0.3% month over month increase vs expectations for a decline.
But the biggest market mover by far was the shocking FOMC meeting. While investors widely expected the Fed to keep interest rates unchanged – and they did – it was the Summary of Economic Projections (SEP) that shocked investors. The SEP was expected to show that the Federal Reserve had no plans to lower interest rates in 2024. The Federal Reserve was expected to remain hawkish in an attempt to continue their fight to lower inflation to 2%.
But in a shock to everyone, the Federal Reserve’s SEP actually showed 3 rate reductions in 2024. Markets across the board, from stocks to bonds to treasuries, rallied on the news. In classic fashion however, stock and treasury traders took it too far by over-buying stocks and bonds. The markets are now pricing in 6 rate cuts in 2024 vs the Fed’s projected 3 rate cuts.
Throughout all of 2023, the stock market rallied over hopes of Fed rate cuts, only to sell-off as those hopes were destroyed. Investors are now wondering if perhaps stocks and bonds are overbought, and due for a pull-back to get back in line with Federal Reserve’s projections of only 3 rate cuts next year.
Despite the massive stock market rally last week, market sentiment actually dropped slightly. The CNN Fear and Greed index (https://www.cnn.com/markets/fear-and-greed) decreased one point to 67, although it remains solidly in the Greed stage. Bond traders in particular appear to getting more bearish about the market, while equity traders (stock market investors) remain in Extreme Greed. Fear is that it is only a matter of time before stock market traders follow in the steps of bond traders, resulting in a significant stock market pull-back.
The VIX followed in line with the Fear and Greed index. Despite a massive rally in the equity markets, the VIX barely moved. The VIX finished the week down just 0.57%, although it did finish at a new 52 week low. Despite the rally, options traders were unwilling to buy more call options. The flat trading VIX is one of the reasons why the Fear and Greed index fell. Options traders appear unwilling to continue buying this market, and it’s only a matter of time before the number of sellers exceeds the number of buyers, resulting in a decline in the stock market.
The daily charts have become extremely overbought on all four market indices. The RSI is above 70 on all four indexes, and the DOW’s RSI is at an amazing 86. That is the highest RSI on the DOW since January 2018, right before the market dropped 11% in 9 days. And the S&P 500’s RSI is the highest it’s been since September 2020, right before the market dropped 10% in 3 weeks. It’s a huge warning that the market is due for a quick pull-back before continuing higher. I went into more detail about what’s happening on the technicals here: https://www.youtube.com/watch?v=maBS8tU8Ypg&list=UULFxFRGG-_23Kqxe0YexDc1eg&index=2.
The weekly charts are in line with the daily charts. They are also over-bought and indicating a pull-back, though not as extreme as the daily charts are. A 6% to 7% pull-back in the market is now needed to correct the overbought situation we’re in.
This week will be light on economic news, although there is still some important data to pay attention to. This week we get a lot of housing data, which is expected to remain dismal. Home builder confidence is being released on Monday, housing starts are being released on Tuesday, and existing home sales are being released on Wednesday. All of these are expected to show declines in the housing market.
Friday might actually be the biggest market mover when it comes to economic data. On Friday, we get durable goods orders for November, the Personal Consumption Expenditures Index (PCE), which is the Federal Reserve’s preferred measure of inflation, and new home sales for November.
Here’s the full list of all of the economic news coming out this week as well as the time each report is being released: https://www.marketwatch.com/economy-politics/calendar
Here’s what time each Fed member is speaking this week: https://www.federalreserve.gov/newsevents/calendar.htm
Although earnings season is over, we still have a few big companies reporting this week, including Accenture and FedEx on Tuesday, General Mills and Micron on Wednesday, and Carnival and Nike on Thursday.
Other Things to Know
The Market is closed on Monday, December 25th for Christmas, so plan your options trades accordingly, especially towards the end of the week.
Bitcoin recovered slightly last week, but then sold off again this weekend. It remains above the critical 21 EMA support level on the daily chart, which I am watching closely. Should it drop below the 21 day EMA, I will be closing all of my crypto call options and taking profits.
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Wishing you the best of success trading this week,