Don't be fooled by this S&P shakeout move

A number of indicators suggest that the risk of a S&P 500 shakeout move is elevated. As implied by the label, a shakeout move tends to shake out the weak hands before the next big move. What is the shakeout move and what evidence supports a shakeout move?

The shakeout direction

The S&P 500 trend is up, so the shakeout move will occur to the down side.

The shakeout catalyst

What evidence suggests a pullback (the shakeout move)?

Although the S&P 500 (price) has been advancing, measures of internal stock-market strength have been deteriorating. The chart below plots the S&P 500 against the percentage of S&P stocks above their 50-day SMA. Although this is a pretty basic indicator, it shows that the latest rally leg is built on shaky ground.

Like a block of ice, this rally may appear solid, but rising temperatures easily melt perceptions of solidity. The red trend line indicates that a “change of temperature” could be near.

The shakeout eventuality

A shakeout is only a shakeout if the predominant trend resumes thereafter. What evidence supports a continued uptrend following the shakeout pullback?

Following the June low at 1,991, the S&P rallied strongly. In fact, the July 4 Profit Radar Report pointed out that the rally from the June low was stronger than the rally from the February low at 1,810.

This rally sported a rare breadth thrust, the kind of thrust that's been seen only eight times from 1970-2015, and twice in 2016. For more details, see the Feb. 25 article "2016 Bear Market Risk is Zero Based on this Rare but Consistent Pattern."

The bullish February and June breadth thrust are in harmony with the Profit Radar Report's 2016 S&P 500 forecast (published Jan. 31), which projected the S&P 500 to finish the year at 2,218.

Although the 2,218 year-end target was highly contrarian when the S&P traded around 1,900, recent activity suggests it may actually be too low.

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