We’ve been covering the signs of weakness for stocks, from the bearish divergences in March, to the mega-cap growth stocks breaking through their 50-day moving averages, to even the dramatic increase in volatility often associated with major market tops. While Q1 was marked by broad market strength and plenty of new 52-week highs, Q2 has so far provided a much different playbook for investors. Both bulls and bears have felt validated by the recent choppiness for the major market averages.
Over the last week, the S&P 500 managed to gain about 2.7%, despite some hotter-than-expected inflation data and a mixed bag of earnings for the Magnificent 7 stocks. Does this set us up for much further gains, and a potential break to new all-time highs, as we continue through the second quarter? Or are we currently experiencing the “dead cat bounce” phase with a countertrend move to the upside before the great bear market continues?
Psst! Check out the January 2024 edition of this exercise, and guess which scenario actually played out!
Today, we’ll lay out four potential outcomes for the S&P 500 index. As I share each of these four future paths, I’ll describe the market conditions that would likely be involved, and I’ll also share my estimated probability for each scenario. And remember, the point of this exercise is threefold:
Consider all four potential future paths for the index, think about what would cause each scenario to unfold in terms of the macro drivers, and review what signals/patterns/indicators would confirm the scenario.Decide which scenario you feel is most likely, and why you think that’s the case. Don’t forget to drop me a comment and let me know your vote!Think about how each of the four scenarios would impact your current portfolio. How would you manage risk in each case? How and when would you take action to adapt to this new reality?Let’s start with the most optimistic scenario, involving a move to new all-time highs over the next six to eight weeks.
Option 1: The Very Bullish Scenario
If you think the April pullback was just another buyable dip within a primary bullish trend, then the Very Bullish Scenario is for you. This scenario would be made possible only if the Magnificent 7 stocks returned to their former magnificent ways, with stocks like AMZN and NVDA following GOOGL in making new all-time highs.
We’d need to see economic indicators, especially inflation readings, come in much weaker, which would give the Fed confidence to begin cutting rates at the June Fed meeting. By the end of June, we’d be talking about the S&P 500 breaking above 5500, and even 6000 could be on the table.
Dave’s Vote: 10%
Option 2: The Mildly Bullish Scenario
What if the S&P manages to hold the April low around 4950, but is unable to push to new all-time highs? Scenario 2 could mean that value-oriented sectors like industrials and materials experience a resurgence, outpacing the growth leadership stocks from Q1. But since these sectors are much lower weight in the S&P 500, it’s just not enough market cap to move the needle on the major benchmarks.
Perhaps the rest of earnings season yields mixed results, and by the end of Q2 we are left with more questions than answers as the Fed is unable to commit to aggressive rate cuts. Interest rates remain elevated, which creates a major headwind for growth stocks.
Dave’s vote: 30%
Option 3: The Mildly Bearish Scenario
Now we get to two scenarios that would mean a more bearish picture emerges in the coming weeks. Scenario 3 would mean the S&P 500 is unable to hold the April low around 4950, but we remain above a 38.2% retracement level around 4820. The Fed either delays its first rate cut or uses language that exudes little confidence in multiple additional rate cuts in 2024.
The Magnificent 7 stocks would be choppy at best, and as they stall out attempting to return to new all-time highs, investors see that as a signal of limited upside. Gold and gold stocks become the trade of the day, as investors are looking for anything other than stocks to try and generate positive returns.
Dave’s vote: 45%
Option 4: The Super Bearish Scenario
You always have to include a doomsday scenario, and our final option would mean the April selloff was indeed just the beginning. May and June are marked with lower lows and lower highs, and Q2 feels very similar to September and October of 2023. The S&P 500 breaks through Fibonacci support around 4820, and even pushes below the 200-day moving average for the first time since the October 2023 low.
What could cause this last scenario? Economic data could come in way higher than expected, and the Fed could then become unwilling to cut rates while the economy shows signs of renewed strength. The market braces for “higher for longer” interest rates, growth-oriented sectors like technology and communication services begin the lead the way lower, and defensive sectors bump higher as investors ignite the “flight for safety” trade.
Dave’s vote: 15%
What probabilities would you assign to each of these four scenarios? Check out the video below, and then drop a comment with which scenario you select and why!
RR#6,
Dave
P.S. Ready to upgrade your investment process? Check out my free behavioral investing course!
David Keller, CMT
Chief Market Strategist
StockCharts.com
Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.
The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author and do not in any way represent the views or opinions of any other person or entity.
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