Don't Be Surprised by an Early 2025 Pullback

This year has been a very good one for stockholders. Come to think of it, 2023 wasn't so bad either. After an extended period of gains, it's natural for investors to become complacent, especially as they head home for the holidays.

This is the kind of environment waiting to pounce on the unwary. For example, insider buy/sell data is at its most bearish extreme since the financial crisis. Cover stories can often be used as a basis for forming a contrary opinion, which could make Barron's recent cover calling for a 25% rise in stocks quite prescient. I'm not guaranteeing, slam dunk, there will be a correction. I'm merely pointing out that conditions are ripe for some sharp, unexpected downside action. Whether or not the market pulls the trigger is an open question.

Sentiment Vulnerable For a Turn

Chart 1 plots the four-week moving average (MA) of AAII Investors declaring themselves bearish. The red arrows indicate this data generally moves in the opposite direction to the S&P 500 ($SPX), as falling prices attract more bears and vice versa. The indicator recently broke above its post-2022 down trendline and completed a base. I have colored these two lines in green, as it's bullish for the concept of an expanding number of bears. However, red may be more appropriate, as an expanding number of bears and, therefore falling prices are predicted by these breakouts.

Chart 2 displays a 30-day MA of the CBOE Total Put/Call Ratio ($CPC). The solid red vertical lines show that significant upside reversals in the ratio are usually followed by some kind of a decline in the S&P 500. The dashed ones remind us that in really strong markets, this relationship is not so reliable.

Since mid-2023, the S&P 500 has been working its way higher against a backdrop of lower ratio peaks, which is a sign of complacency. The put/call data is currently falling, indicating a trend of expanding bullishness, so it's not flashing a sell signal at this time. However, its current low reading reflects above-average complacency, from which an upside reversal is likely to signal some corrective action.

Breadth Is Not So Broad

Chart 3 shows that the common stock and regular NYSE A/D Lines have kept pace with the NYSE Composite and have not yet experienced any negative divergences from which a decline could be projected. Both, however, have violated their bull market trendlines, which suggests a serious loss of upside momentum.

A different story is told when we drill down to alternative measures of breadth. For example, Chart 4 features the Cumulative McClellan Oscillator based on data from the Common Stock A/D Line. The NYSE reached a new high earlier in the month, but a negative divergence preceded this action. The potentially weakest part of this setup, though, is that the all-time high in the index was accompanied by an oscillator unable to ally above zero.

There is an old two-part technical rule that says first when a momentum indicator cannot rally much above its equilibrium point, as the price is touching or exceeding a new high, expect an above-average decline. Second, this setup is inoperable until the price confirms this weak momentum with a trend break of its own. As a testament to this principle, look at the three previous setups featured in the chart.

Further evidence of narrowing breadth is presented in Chart 5, where the 10-day MA of the NYSE percentage of stocks above their 50-day MA has been diverging negatively with the index since the beginning of the year. Indeed, the oscillator was only recently able to generate a reading of 60% or so, barely above the 50% halfway mark. Now, both series are threatening key support trendlines. Their decisive violation would confirm a more extensive correction was underway.

The Recent Rally Lacked Volume

It's normal for volume to go with the trend, so this lack of enthusiasm is a bad sign when the price rallies and volume shrinks. In that respect, the vertical lines in Chart 6 show when the Percentage Volume Oscillator (PVO) for the SPDR Dow Jones Industrial Average ETF (DIA) bottoms out from below the oversold level. Most examples are followed by a decline of some kind since the preceding rally left the market in an overbought condition and subject to a correction. The indicator is currently in an oversold condition (crossed below the blue dashed line) but has yet to bottom.

A Likely Pullback

There is no consensus of evidence proving that the bull market is over. However, US equities are currently being supported by weak underpinnings, complacency, and overly optimistic sentiment, which suggests vulnerability. A mini-year-end rally is possible, but if the NYA decisively violates its 2023-2024 bull market trendline before then, it might be time to take partial profits in what is likely to be an ongoing bull market.

Good luck and good charting,

Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Groupof Walnut Creek or its affiliates.