Where can I find bullish confirmation?

No major corrections coming, but no erupting bullish sentiment either…the crosswinds hitting the S&P…ours Strategic trader Analysts pay attention to… their market forecast

Our technical experts John Jagerson and Wade Hansen say we can rule out a large move lower.

But if you expect a strong sustained uptrend, don’t hold your breath.

So where does that leave us?

Waiting for more accurate data.

According to John and Wade, investors today are stuck between two conflicting crosswinds…

Relatively strong market fundamentals, resilient enough to prevent a major pullback, but growth expectations too weak to support a rampaging bull.

Let’s take a closer look.

Why Investors Don’t Have to Fear a Big Selloff

Before we dive into our analysis, for our newer Digest readers, John and Wade lead our trading newsletter: Strategic trader.

This premier trading service combines options, insightful technical and fundamental analysis, and market history to trade the markets whether they’re rising, falling, or flat.

John and Wade’s arsenal of trading indicators provide helpful insights into the likely future direction of the market.

That brings us back to where investors are today.

Let’s start with the good news. Despite a mixed earnings season so far, John and Wade don’t think we’re at risk of a major sell-off in the market. Why not?

Our technical analysts point out the respectable shape of the profit margins.

From her latest Strategic trader To update:

… As inflation has risen, costs have risen (and continue to rise) and profit margins have fallen.

According to FactSet, profit margins across the S&P 500 this quarter should come in at about 11.4%, continuing the decline from 2021 highs of 13%.

On the surface this looks bad, but profit margins between 8-11% in the S&P 500 are the long-term norm, not the exception…

There’s no reason to believe that stocks can’t find themselves in a bull market again when profit margins fall back to their long-term average.

If you read yesterday’s Digest, that seems familiar to me. Yesterday we pointed out that analysts’ expectations for 2023 profit margins are indeed higher.

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And we’ve asked how that could be, as it looks like we’re headed for a period of economic weakness.

To be clear, we remain concerned that rosier than warranted profit margin estimates could lead to a market sell-off if these expectations are not met later this year. But John and Wade are right that a return to “average” profit margins is enough to support longer-term market gains (albeit possibly after Wall Street threw a brief tantrum at lower-than-expected profit margins).

Either way, this is a dynamic that won’t unfold until later in 2023.

So what is the bearish influence that will prevent stocks from bursting into wild bullish moves?

growth expectations.

Back to John and Wade:

The big X factor this quarter that could keep the market within its recent range is the growth outlook.

Regardless of the current numbers, if management takes a negative outlook, we could see short-term profit taking.

While we don’t think market fundamentals warrant a negative view, we do think it wise to exercise caution.

John and Wade point to Wall Street’s reaction to Microsoft’s earnings report earlier this week as a perfect example of this tension between bulls and bears.

While Microsoft beat earnings forecasts, Microsoft saw its cloud computing platform (Azure) grow 38%. The strong performance sent Microsoft shares up 5% in after-hours trading on Tuesday.

But then came the discussion of future growth.

Here are John and Wade with these details:

However, immediately following the report, MSFT’s CFO told investors that management expects the growth rate to slow by 4-5 percentage points.

On the MSFT 5-minute chart below, you can see the whiplash that occurred in the post-market (blue shaded area).

Source: TradingView

The bottom line here is that market fundamentals are strong and should sustain the market above its lows, but the trend in growth rates needs to improve to warrant a heavily bullish outlook.

The “sign of confirmation” that John and Wade are waiting for

On Monday Digest, we presented a chart of the S&P showing it moving into its multi-month downward sloping trendline. The question was whether the bulls would have enough strength to finally break this critical resistance level.

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Here is Monday’s chart.

Chart showing the long-term declining trend line of the S&P

Source: StockCharts.com

Well it happened.

This week, the S&P finally pushed north through this key resistance point.

That’s big. It is a clear show of strength that suggests the market could be on the verge of a major directional change.

This is what it looks like…

Chart showing the S&P finally breaking its long-term resistance line to the north

Source: StockCharts.com

But while John and Wade are encouraged by this breach of resistance, it’s not enough for them to hit the ground running.

Here they are with what else they want to see:

…We’re still waiting for confirmation from the other major indices before we get too excited.

Confirmation from the other major indices – particularly small cap stocks – would consist of breakouts from their previous highs.

For example, although the S&P 500 has surpassed a critical technical level, the small-cap Russell 2000 Index is facing strong resistance at 1,900.

While an investor might be betting on the S&P’s resistance break alone, John and Wade tell us that waiting for a breakout to be confirmed is a classic technique to reduce the possibility of buying a false breakout or “whip saw.”

Back to Strategic trader Update on when we might see the Russell bullish breakout:

As long as the Fed doesn’t act too aggressively next week, we think a solid confirmation signal could appear from the Russell 2000 when the February 3rd jobs report is released.

John and Wade wrote their update on Wednesday. As I write over lunch on Friday, the Russell is trading at 1,905. We will monitor if this level holds and can support a fresh bullish rise.

All together, how do John and Wade view the market conditions ahead?

Overall, our technical experts are satisfied with the results of the earnings season so far compared to long-term trends.

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While the outlook has been mixed – which they say is “worrying” – they see no significant threats to market support.

Here’s their prognosis as they look ahead:

The fresh breakout in the S&P 500 is encouraging, but we recommend waiting for confirmation before shifting your bias in a more bullish direction.

For now, we plan to remain focused on earning income from our long positions on the highs and selling puts on quality stocks when they hit the lows.

While the outlook for 2023 is still somewhat neutral, we are optimistic that there will be many more opportunities for short-term gains as the first quarter progresses.

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Meanwhile, keep an eye on the Russell 2000 to confirm the strength of this recent bull rally.

Have a nice evening,

Jeff Remsburg