A Breakout to the Upside is Just Around the Corner for the Stock Market. Don't Rush

The U.S. stock market is approaching a potential "buy" signal, according to several technical indicators. One key signal is coming from the S&P 500, which is being tracked alongside the Intermediate Term Breadth Momentum Oscillator (ITBM). This reliable indicator, paired with the 14-day Relative Strength Index (RSI), has shown signs of becoming oversold. A buy signal is typically triggered when the RSI recovers from oversold levels and moves back to a neutral position, which may be in the near future.

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While I remain cautious in the short term, I believe that a significant upside breakout is on the horizon. Investors just need to be patient. Over the last few weeks, the S&P 500 has largely been moving sideways, but last week, it broke through to reach an all-time high. This sideways movement, coupled with some internal market dynamics, suggests that a larger rally could be just around the corner. However, certain factors are raising short-term concerns. Specifically, negative RSI divergences and a decline in the number of net 52-week highs versus lows point to a short-term bearish outlook. Despite these cautionary signals, other indicators remain supportive of an intermediate-term bullish trend. One of these is the percentage of stocks that are currently trading above their 50-day moving average, which reflects broader market strength and a bullish trend that could persist in the weeks ahead.

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In contrast, the bond market presents a potential headwind for stocks. The yield on the 10-year U.S. Treasury has climbed above 4%, which could put downward pressure on stock prices. This rise in yields appears to be driven by two main factors: a stronger-than-expected Consumer Price Index (CPI) report and uncertainty surrounding the upcoming U.S. presidential election in November. Both of these factors are contributing to the increase in yields and adding to market volatility.

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The Cboe Volatility Index (VIX), a widely followed measure of market volatility, also reflects increased anxiety in the market. On November 11, the VIX closed above 20, signaling heightened market fear. A deeper analysis of the VIX term structure shows a somewhat unusual pattern. Between one and three months, the term structure appears flat, a signal of fear in the market. However, between nine days and one month, the term structure has a steep upward slope, suggesting that while there is underlying anxiety, the options market is also showing signs of complacency. This duality could be a reflection of election-related uncertainties that are likely contributing to market nervousness.

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The immediate challenge for the market is to navigate through the uncertainties of October. However, market internals suggest that the downside risk may be limited. The NYSE McClellan Oscillator (NYMO), another measure of market breadth, is approaching oversold levels despite the overall sideways-to-positive movement in the broader market. This indicates that the market may not have much more room to fall, and any decline could be relatively mild.

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In addition to the McClellan Oscillator, the advance-decline (A-D) line, which tracks the number of advancing versus declining stocks, is showing healthy market breadth. Most of the A-D lines, including those tracking larger indexes like the S&P 500, reached fresh recovery highs in early October. The only exception to this pattern is the A-D line for the S&P 600 small-cap index, which has lagged slightly. Despite this, the strength in the broader A-D lines suggests that the market is not exhibiting the kind of behavior typically seen at major intermediate-term market tops. This further supports the case for intermediate-term bullishness.

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In summary, stock market internals are presenting a mixed picture. While there are signals that warrant near-term caution, particularly with the uncertainty surrounding the election and the strong CPI report, the broader indicators suggest an underlying strength. The intermediate-term outlook remains bullish, with several factors pointing to a market that is near oversold and could be set up for a strong rally. For now, investors should exercise patience and keep an eye on the technical signals that suggest a buy opportunity may soon emerge.

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Ultimately, the combination of market breadth, technical indicators, and the reaction to external factors like Treasury yields and election-related volatility is creating a compelling setup for a potential bullish move. Investors who can wait out the short-term uncertainties may be rewarded with a strong upside breakout in the coming weeks.

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