The Stock Market is Set for a Relief Rally

A rebound in the stock market that appeared to be taking shape at the beginning of the week is being evaluated with a degree of caution by a Wall Street analyst. According to the assessment of this analyst, the scope for significant gains from pursuing a recovery from the current level is somewhat constrained.

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The downward trend in stocks that persisted throughout August extended into a third consecutive week, culminating in the close of Friday's trading session. This trend was in response to remarks by Federal Reserve Chair Jerome Powell during the Jackson Hole economic symposium. Powell's statement highlighted the ongoing uncertainty surrounding the necessity of further interest rate increases, as policy makers remain uncertain about the potential need for additional rate hikes. This insight was provided by Tyler Richey, Co-Editor at Sevens Report Research.

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A notable surge in stock market volatility became evident through the Relative Strength Index (RSI) indicator, a measure utilized to assess whether an index or a stock has experienced overvalued or undervalued conditions due to recent price fluctuations. The RSI traditionally considers a reading above 70 as overbought and below 30 as oversold.

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The RSI chart illustrated a movement into overbought territory midway through the week, followed by a transition into oversold territory on Thursday.

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Despite Friday's "whipsaw drop to new lows for the week" in S&P 500 futures (ES00, 0.84%), this decline did not correlate with new lows in the RSI indicator. Consequently, this incongruity suggests the potential for a relief rally at the commencement of the new week, focusing on resistance levels in the range of 4,465 to 4,515. Tyler Richey highlighted this prospective scenario in a note on Monday.

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The successful realization of such a relief rally, including its ability to surpass the downward trend line established in August, holds significant implications for the near-term trajectory of the stock market. Failure to breach this trend line would suggest a predisposition for further declines in stock prices.

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During Monday's trading session, U.S. stocks continued to recuperate from the pullback experienced in August, with the S&P 500 index posting its first consecutive daily gains in a month.

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The S&P 500 index advanced by 27 points, or 0.6%, to conclude at 4,433 on Monday. Similarly, the Dow Jones Industrial Average recorded an increase of 213 points, reaching 34,559, while the Nasdaq Composite surged by 0.8% to 13,705. According to FactSet data, the S&P 500 has incurred a monthly loss of 3.4%, signifying its most substantial monthly decline in 2023. Correspondingly, the Dow industrials fell by 2.8%, and the Nasdaq Composite exhibited a month-to-date decline of 4.5%.

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This decline contrasts with the robust rally earlier in the year that was driven by artificial intelligence, resulting in the Nasdaq's strongest first-half performance since 1983.

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The Nasdaq Composite's potential for a relief rally is strategically positioned, with an attainable target of 14,000 in the very immediate future, as per Richey's analysis. Nonetheless, this upside potential may eventually transition into a resistance level, especially if it's reached early in the fall.

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Technical indicators for the Nasdaq Composite reveal a mixed but slightly bear-favoring orientation, with the RSI being the sole indicator favoring bullish sentiment. A notable aspect is the declining blue line in the middle sub-chart, depicting the Nasdaq's relative strength compared to the S&P 500. This downward trend supports the bearish outlook for the upcoming months, according to Sevens Report Research.

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Moreover, a notable shift occurred in the bond market, specifically in Treasury yields. The yield on the 10-year and 30-year Treasuries reached their lowest levels in over a week, while the yield on the 2-year Treasury reached its highest since March 8. This shift, known as a "negative yield-curve twist," involves shorter duration yields increasing while longer duration yields experience significant declines. Richey pointed out that this movement suggests expectations of further economic deterioration amidst a persistently hawkish stance by the Federal Reserve.

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The commentary concludes by acknowledging that while the potential for a near-term relief rally in stocks is elevated at the start of the week, the feasibility of substantial upside gains is limited considering the broader market trends. The recent "negative yield-curve twist" further underscores this cautious stance, emphasizing the historical susceptibility of the financial system to disruptions in such situations.

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