Market Overview
The market remains constructive on the surface, but conditions underneath have become less supportive. The S&P 500 continues to hold near its highs, while participation has weakened and rising interest rates are creating an additional headwind for equities.
I do not believe the evidence currently points to a major market breakdown, but the combination of weakening breadth, reduced risk appetite, and higher yields warrants a more cautious approach. For now, I am watching for either improving participation that confirms the market's strength or further deterioration that would signal increasing risk.
SPY: Holding Up Despite a More Cautious Market
The S&P 500 continues to display relatively constructive price action despite the recent deterioration in risk appetite. After reaching a new high in August, the index has consolidated sideways and remains above its rising 50-day moving average and an important area of support. Price is also currently trading near its shorter-term 10 and 21-day moving averages.
While this chart does not currently signal a major breakdown, the sideways action suggests that momentum has slowed. More importantly, the strength of the index itself does not tell the entire story. As we will see in the next chart, participation beneath the surface has weakened considerably, creating a divergence that warrants caution.
Market Breadth: A Warning Beneath the Surface
Although the S&P 500 continues to hold up relatively well, market breadth is telling a more cautious story. The lower panel measures the percentage of S&P 500 stocks trading above their respective 50-day moving averages. That number has recently fallen to approximately 43%, meaning that less than half of the stocks in the index are currently above this important intermediate-term trend measure.
More importantly, breadth has deteriorated while the S&P 500 remains relatively close to its highs. This negative divergence tells us that fewer stocks are participating in the market's strength. It does not necessarily mean that a larger correction is imminent, but it is an important warning sign and reduces my confidence in the seemingly constructive price action of the headline index.
Rising Yields Create a Market Headwind
One factor contributing to the market's more cautious tone is the continued rise in interest rates. The 10-year Treasury yield has been trending steadily higher since March and is now approaching 4.8%, near its highest level of the past year.
Higher yields create competition for stocks and can put downward pressure on equity valuations, particularly in higher-growth areas of the market. This does not mean that rising rates will necessarily cause a market correction, but combined with weakening breadth and reduced risk appetite, the trend in yields represents an important headwind. A continued move toward or above 5% would increase my concern, while a reversal lower would remove some of the pressure currently facing equities.
Client Account Update
Client accounts remain positioned defensively, reflecting the deterioration in market breadth, weakness in many growth-oriented stocks, and the continued rise in interest rates. Equity exposure is currently concentrated in a relatively small number of positions that continue to demonstrate favorable technical characteristics, while I am maintaining a meaningful cash position until the market provides stronger evidence that conditions are improving.
Our conservative model's bond allocation remains fully invested and continues to perform well, providing both diversification and stability during the recent weakness in equities.
For now, I believe patience is warranted. I am prepared to increase equity exposure when market conditions and individual stocks begin providing better opportunities, but I see little reason to force additional exposure while the evidence remains mixed.