Administrative Note: July is vacation month for myself at Signal Sigma; there will be one more period with no market updates (unless warranted by exceptional circumstances):

• 25-31 July

Meanwhile, the development team is working full time toward the production of the radical new version of the platform (see updates at the end of this article).

-Andrei

After an eventful weekend which featured the failed assassination attempt of the leading U.S. Presidential candidate, asset markets have cast their vote.

Note: I will refrain from making any political statements in my coverage as 1) I’m not eligible to vote in the U.S. Election and 2) White House policy is rarely impactful for equity markets longer term; Fed policy remains our focus. - Andrei

With that being said, we need to examine the way traders have responded to the recent headlines, and understand if the stock market is effectively front running a Donald Trump presidential win in November. According to betting website polymarket.com, the odds of Donald Trump winning the election jumped from 60% before the weekend to 70% now.

At the same time, the odds of Biden dropping out of the race have substantially decreased, from around 66% before the weekend, to 34% today. The rationale here is that Biden will be allowed to lose by the Democratic powers that be, in order to shield any other potential candidate (Kamala Harris / Michelle Obama) from a near certain Trump win.

As a result, stock markets have every incentive to treat the result of the US Election as a foregone conclusion and price in all eventual policy changes well ahead of the first ballots being cast. Historically, the market doesn’t care who wins. What does matter to investors is an orderly election process, a peaceful transition of power and predictable (ideally gridlocked) legislative landscape. On that note, if the assassination attempt would have been successful, we probably would have witnessed a limit-down bloodbath at the open on Monday for the S&P 500.

Fortunately, that is not the case and unity seems to prevail, at least for the moment. A message of inclusivity and toning down hateful rhetoric is being broadcast across both party lines. We would argue that this is a bullish development for equity markets, as the sessions on Monday and Tuesday have demonstrated.

However, that does leave SPY meaningfully overbought, as the rally is nearing a buyers’ exhaustion level. Our 1-year price target of $582, set less than 2 months ago, has nearly been reached, leaving just +3% of potential gains. Support climbs to $551, as the 20-DMA trails the ascent. A retracement to the 20-DMA would imply a -2.3% decline for the benchmark ETF.

In terms of Market Internals, an almost seismic shift has occurred, as breadth has dramatically improved. The Z-Score divergence (recording the differential between large cap and broad market performance) has dropped off a cliff, as small caps rallied.

Improving breadth can also be seen at the moving average level, with the number of stocks trading above key averages spiking:

And sentiment (basically another breath measure), is now close to triggering a contrarian SELL signal, as the number of overbought stocks rises sharply. We’re not just there yet, but the market is close to entering “Extreme Greed” territory.

Predictably. the iShares Russell 2000 ETF (IWM) is off the charts, rallying +10% in the last week. All technical resistance levels have been surpassed.

During the same timeframe, SPY gained just +1.41%, QQQ is down -0.58% and large cap growth companies (MGK) lost -0.85%. This is a clear indication that a significant rotation is occuring, and it has yet to run its course. The QQQ relative to SPY chart is telling as the comparative outperformance in this corner of the market is seeing a downturn.

Our Trading Strategy

We are following our established trading protocols by adjusting stop-loss levels in our portfolio positions, especially in QQQ and IVW correlated positions. No trades need to be enacted just yet, and we are clearly not chasing small caps at this juncture. After all, the Russell 2000 is an index comprised of 40% unprofitable companies, so we need to be selective. Our IWM correlated positions are closer to their sell targets at this juncture, so we need to capitalize on their advance soon.

An opportunity is opening up to shift some allocation into large cap growth stocks (big tech). But there probably is more selling to come, so we won’t be greedy here. Instead, if any stops do trigger, we’ll simply reduce overall equity market exposure and wait for the next big opportunity to buy the dip.

Signal Sigma PRO members will be notified by Trade Alert of any live portfolio changes (if subscribed). If you’re not on this plan yet, you can get a free trial when you join our Society Forum. If you need any help with your trading strategy (or would like to implement one on your account), feel free to reach out!