A thrust signal with an almost perfect record triggered an alert

Key points:

• Over 90% of S&P 1500 stocks closed above their respective 50-day moving average 
• After similar thrusts, the S&P 500 was higher 96% of the time over the subsequent six months
• The equal-weighted S&P 500 tended to outperform the cap-weighted version across all horizons

Participation is on the rise across the entire market-cap spectrum 

An old Wall Street adage says the market climbs a wall of worry. For most of 2023, one of those worries centered around the lack of participation from most stocks. 

For those who analyze market history, much like the team at Sentimentrader, the understanding is clear: rising interest rates create a dichotomy of winners and losers, with a noticeable decline in overall participation. 

However, as the interest rate environment improves, stocks tend to rally sharply, a trend that has unfolded in the last six weeks. 

On Tuesday, the percentage of S&P 1500 stocks closing above their respective 50-day average increased above 90% for only the 26th time since 1962. The previous signal occurred in May 2020, leading to a substantial stock rally.

Similar medium-term thrust signals preceded excellent returns

Whenever the percentage of S&P 1500 stocks trading above their 50-day moving average increases above 90%, like now, the S&P 500 displayed outstanding results across all time frames. Three and six months later, the world's most benchmarked index was higher in all but one precedent. A year later, it was higher in all but two cases.

To provide a similar context to now, I required the indicator to fall below 20% before a new signal could be triggered again.

Favorable risk/reward

Over the following twelve months, the S&P 500 experienced only one loss exceeding -10% and five more significant than -5%. The median drawdown was a minuscule -1.2%, while the median drawup (maximum gain) was +19.2%. 

Suppose I apply the signals to the equal-weighted S&P 500, where each of the 500 stocks holds an identical weight, rather than the capitalization-weighted index that gives preference to the largest stocks. In that case, the forward return outlook is even more impressive. 

Relative comparison

Comparing the two index weighting methodologies suggests investors would have been better off holding a position in the equal-weighted index, which is now easily attainable via an ETF like RSP.

Sectors and Industries

While the outlook for all sectors and industries is bullish, cyclical-oriented stocks tend to outperform defensive ones.

What the research tells us...

A former money manager, George Chestnutt, once said, "The best forecaster of market action is the action of the market itself." With over 90% of S&P 1500 stocks in medium-term uptrends, the S&P 500's outlook is highly favorable. Mr. Market has spoken. Are you listening?