Can The S&P 500 Defy Gravity?

S&P 500 Grinds Higher

For the last six weeks, we have cautioned that a correction in the S&P 500, based on probability balance, is likely. However, the index continues to defy gravity and grind higher.

We were not surprised by the drawdown in April. In our 6 January post, we noted that our instinct was that the index would likely experience a significant pullback in the first quarter or early in the second quarter.   

We were not surprised by the rally into late May and early June. However, we have been surprised that the market has not had a significant correction of 5-10% in July or early August.

The current fundamental and technical analysis factors that shape our bias and probability balance mirror those seen at the start of the year.

Fundamentals

The MOVE index, which is a guide to bond volatility, is at an all-time low.

The VIX, despite the hot PPI report last week, is below the 10-day realised volatility for the first time since late May.

High-yield spreads are tight and showing signs of complacency amid mounting growth risks.

Positioning is very extended, and from a technical analysis perspective, momentum is stalling.

The index is in record territory in price and near record territory in valuations.

Most investors don’t use stock valuations as a timing tool, and that makes sense. Investors are more sensitive to earnings.

Valuations are expectations of future performance, and high valuations don’t mean the index will not be at an all-time high at the end of 2025.

Confluence Of Signals

None of these factors in isolation is a clear indicator that the market will correct.

That said, it’s rare to see such a confluence of signals. The situation was similar at the beginning of the year, and as we anticipated, the outcome was a correction to the downside.

Add to the mix the reason for the recent rally, whether it be the expectation of rate cuts or the removal of tariffs.

Tariffs are back, and even if rate cuts do materialise, they may not have the impact that many anticipate. The FED can only influence short-term interest rates.

If you combine all of the factors above, while it’s not a guarantee that the market will crash, it does suggest that it’s the environment in which a significant and quick correction is likely.  

Asset markets don’t move in a straight line. They don’t go straight up to the right indefinitely.

While making money is the ultimate goal for investors, it has to be combined with capital preservation.

As a minimum, it is a time for caution.