Stocks delivered a disturbing signal last week. Here’s what it may mean.

Stocks delivered a disturbing signal last week. Here’s what it may mean.

After rising 14.5% in the first six months of the year, futures early Monday indicate the S&P 500 will struggle to begin the second half of 2024 extending those gains.

Indeed, the cautious start to July follows a disconcerting technical end to June that leaves stocks vulnerable to a pullback, says Michael Kramer, founder of Mott Capital Management.

In a blog post over the weekend Kramer notes that the S&P 500 on Friday closed down 0.4% having traded about 0.7% higher at a fresh record intraday high.

That 1.1% top to bottom retreat delivered what’s called a bearish engulfing candle, where Friday’s ultimately lower close was part of a range bigger than Thursday’s positive session.

Those of a technical bent consider the phenomenon to be a decidedly negative signal. And as the chart below shows, it was the second such candle in a week, delivering what Kramer call a “2b top reversal pattern”.

“This pattern often forms when an index or stock attempts to make a new, fails to hold that high, and then closes below the previous closing high,” says Kramer.

He also notes that last week’s S&P 500 high surpassed the previous week’s but closed lower over the latest five-session period. That has only happened eight other times since January 2020, and on seven of those occasions the S&P 500 has fallen over the following week, by 35.3%, 11.2%, 14.4%, 12.9%, 19.3%, 2.1% and 2.5%, Kramer calculates.

There was only one time the index moved higher: in January 2021. “So, the signal carries some weight with it and should not be ignored or easily dismissed,” says Kramer.

For the ‘2b top’ trading pattern to be invalidated, the S&P 500 will have to close above 5,487.02 one day this week, Kramer says.

Kramer has some other indicators to support his caution. He notes the CBOE 1-month implied correlation index — an options-based tool that can be used to gauge market breadth — closed at a record trough of 5.59%, well below the previous low of 6.78 in October 2017.

He’s also wary of the VanEck Semiconductor exchange traded fund whose 20-day moving average is providing support at around $255, but if broken would confirm a move lower has begun.

In addition, high-yield credit spreads — a measure of nervousness about riskier corporate borrowers — have started trending higher even as stock prices have risen. Kramer observes that we last saw these conditions develop was in January 2020 and the fall of 2021, two periods that preceded notable stock market pullbacks.

Going back to the previous occasions when a ‘2b top’ was observed, Kramer acknowledges that investors may say it is ridiculous to think the S&P 500 could drop by some of the above-mentioned values.

”I could also argue that it would have been foolish to believe that the S&P 500 could rally as much as it has since the October 2023 low,” he says, given it has done so with overnight rates at 5.33% and the Federal Reserve draining its balance sheet.

“So caution is warranted currently, and being cautious is not the same as being short or perma bearish. It is about assessing the odds and managing one’s risk,” says Kramer.

Markets

U.S. stock-index futures are mixed as benchmark Treasury yields nudge higher. The dollar index is lower, while oil prices rise and gold is trading around $2,327 an ounce.

For more market updates plus actionable trade ideas for stocks, options and crypto, subscribe to MarketDiem by Investor’s Business Daily.

The buzz

U.S. economic data due on Monday include the S&P final manufacturing PMI for June at 9:45 a.m. Eastern, construction spending for May at 10:00 a.m., and ISM manufacturing for June at 10 a.m.

French stocks are jumping by the most in nearly two years, while the euro is rising and French bond yields are falling after a victory for the far right in the first round of France’s parliamentary elections was not as big as expected.

Boeing has agreed to buy parts supplier Spirit Aerosystems Holdings in an all-stock deal worth more than $4 billion. Spirit shares are up 5%, while Boeing is down just over 1%. Separately, the U.S. Justice Department is reportedly expected to propose Boeing plead guilty to fraud over two deadly crashes of its 737 Max jetliners.

BlackRock  has agreed to buy U.K. data firm Preqin for $3.2 billion.

Best of the web

Tech industry wants to lock up nuclear power for AI.

Bond market participants brace for bigger deficits under either Trump or Biden.

The U.S. deficit is nearly as big as Russia’s economy, and there’s a ‘vicious’ feedback loop that could make it worse.

The chart

The top 10 companies in the S&P 500 make up 35% of the market cap but only 23% of earnings, as the chart below from Tosten Slok, Apollo’s chief economist, shows.

This divergence has never been this great, suggesting that the market is record bullish on future earnings for the index’s top 10 companies, he notes.

“In other words, the problem for the S&P 500 today is not only the high concentration but also the record-high bullishness on future earnings from a small group of companies,” says Slok.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

Random reads

Food crime or food genius?

Finnish hobby horsing.

Just in case subway riding wasn’t miserable enough, here’s 50th Street’s mysterious bell.

Need to Know starts early and is updated until the opening bell, but sign up here to get it delivered once to your email box. The emailed version will be sent out at about 7:30 a.m. Eastern.

Check out On Watch by MarketWatch, a weekly podcast about the financial news we’re all watching – and how that’s affecting the economy and your wallet. MarketWatch’s Jeremy Owens trains his eye on what’s driving markets and offers insights that will help you make more informed money decisions. Subscribe on Spotify and Apple.