The S&P 500 and other major indexes are pausing after hitting fresh record highs, with the market openly debating the next leadership theme set to drive stocks higher. David Keller, president and chief strategist at Sierra Alpha Research, says the answer comes from the charts.
"The game for most people is less about predicting a top or bottom; it's recognizing when the trends have changed," Keller tells Investor's Business Daily's "Investing with IBD" podcast. "I think that's where a lot of investors are on the wrong side of things, and stay on the wrong side of things."
Choosing Levels In The S&P 500
To identify market tops and trends in major indexes like the S&P 500, Keller says he starts with a line-in-the-sand approach. He first defines the trend and then assesses whether it's above moving averages.
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In the case of recent S&P 500 performance, Keller says he chooses 5650, a level that would take a significant market drawdown to hit. The S&P 500 on Thursday closed at around 5780. But Keller warns against thinking too much about downside targets.
"I'm happy assuming the trend is innocent until proven guilty," he says.
Breadth And S&P 500 Action
Keller is, however, keeping a close eye on market breadth, or the ratio of advancing stocks vs. declining stocks. He says that's critical to determining whether a market top is brewing. Breadth divergence can be a core indicator of market deterioration, showing how many stocks are participating in a rally or if it's being led by only a few key stocks.
Bad breadth can reveal underlying problems even as the market continues to advance. Keller says that in 2007, the number of stocks in the S&P 500 making 52-week lows surpassed those making 52-week highs, while other indicators that measure advance-decline data showed a bearish signal.
Those same signals reared their head just before Covid-19 became a wider-spread problem than anticipated by markets, with stocks showing bearish action even as markets continued to advance during the very early stages of the pandemic.
Keller says some of those warning signs have returned to the S&P 500 recently. The trends became visible earlier in 2024, although benchmark stocks like the Magnificent Seven were strong enough to support the market.
Despite a number of positive signs, there are also some indications of a top to watch for in the S&P 500. Keller says to monitor price action signals, like net 52-week highs vs. 52-week lows. Investors should also monitor whether leading names are starting to materially deteriorate.
Trusting In Charts, Not Headlines
Keller says charts also tell the truths that news cycles tend to distort. Traders can be influenced by macro topics like the Fed's expected continued rate cuts, inflation data, tensions in the Middle East and hurricane fears. But those factors may not actually matter to the S&P 500, he says.
"If you focus too much on each of those items and what they could do, you'll go crazy thinking about all of these different possibilities," said Keller.
"That's what I love about using charts and technical analysis," he said. "The markets are arguably the best way to aggregate what everyone is thinking, worried about, concerned about and confident about."
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