Markets Teeter on Edge – Don’t Get Caught in a Selloff Rebound Loop?

Market Performance Remains Within Normal Correctionary Cycles
Despite recent market downturns, historical perspective suggests that corrections are a normal part of market function. As noted last week:“While Trump’s tariffs and bearish headlines currently dominate investors’ psychology, we must remember that corrections are a normal market function. Yes, the market is down roughly 9% from the peak, but we have seen these corrections repeatedly in the past.”

A Closer Look at Market Dynamics

To understand the current market situation better, let’s examine some key indicators. The MACD (Moving Average Convergence Divergence) and relative strength are currently at levels not seen since the October 2022 lows. Furthermore, the market has completed a 23.6% retracement of the rally from those lows, providing the support needed for a potential rally.

Market Rallies This Week

The market tried to muster a rally this week, showing early signs of a bottom forming. However, on Friday, the impact of tariffs and a slightly hotter-than-expected PCE print sent markets tumbling. Despite this setback, the market remains on a buy signal, with improvements in both money flows and relative strength.

Concerns About a Protracted Consolodative Process

The current market dynamics are tenuous at best. While it’s not uncommon for the market to retest recent lows, we’re increasingly concerned about a more protracted consolidative or corrective process. The following chart illustrates potential retracement levels:

• Recent lows: around 5500
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• 38.2% retracement level at 5383
• 50% retracement level at 5146

Managing Risk in a Complex Market Environment

Even if lower retracement levels are possible, and this is the beginning of a larger corrective process, much like in 2022, the market will have intermittent rallies along the way. As noted last week:“Nothing in the market is guaranteed.” Therefore, we must continue managing risk accordingly until the market’s direction is revealed.

Is This a Sellable Rally or a ‘Buy the Dip’ Opportunity?

The honest answer to this question remains uncertain. However, as discussed in “Correction Over?”, there is early evidence that the recent correction may be over, at least for now. Key indicators of investor sentiment and money flows suggest that buyers are beginning to emerge.

What Does This Mean for Investors?

If the correction is indeed over, we need to see evidence of buyers starting to drive markets higher. This will likely involve a more positive trend in both investor sentiment and money flows. For now, it’s essential to remain cautious but not bearish, as sellable rallies will be more frequent in this environment.

Why We Remain Cautious

There are several reasons why we believe the bull market is currently on hold:

• Economic data continues to suggest slower growth.
• The impact of tariff narratives remains a significant concern for markets.
• Recent consumer confidence readings were not encouraging, with expectations for future incomes and employment dropping sharply.

What’s Next for Investors?

Given these challenges, we recommend focusing on more practical steps to navigate the current uncertainty. Some essential strategies include:

1. Tighten up stop-loss levels to current support levels for each position.
2. Hedge portfolios against significant market declines with non-correlated assets, short-market positions, or index put options.
3. Take profits in positions that have been big winners and rebalance overbought or extended positions to capture gains but continue to participate in the advance.
4. Sell laggards and losers; if something isn’t working during a market melt-up, it likely won’t work during a broad decline, eliminating risk early is better than holding onto underperforming assets.
5. Raise cash and rebalance portfolios to target weightings regularly to mitigate hidden risks.

Final Thoughts

The direction of earnings drives markets; our thesis from early this year remains that we will likely see repeated bouts of volatility and lower returns. With slowing economic growth, expectations for earnings growth rates are unlikely to maintain current levels.

We suspect the downward estimates revisions will accelerate somewhat heading into the Q2 reporting season.