[Premium] The Biggest Risks To Stocks In July

1. Let's start with the Island Reversals we saw in the S&P 500 and many other major indices around the world two weeks ago. After two weeks, very few of those indices have broken their respective resistance levels to the upside, but they haven't broken down yet either. Last week we saw some selling across the board, meaning the support levels we outlined are likely to be tested as we head into July.

So our first risk is that the majority of these major indices break down instead of out, signaling a collective shift in appetite for equities amongst global investors. Below we'll review some of the charts from our last post, but we'd recommend viewing that in its entirety.

Here's the S&P 500 with its island reversal intact and prices approaching support near 2,940.

Click on chart to enlarge view.

The Nasdaq 100, arguably the strongest index in the world, negated its island reversal but is still above its breakout level near 9,725. Any move below that level would signal a failed breakout and confirm a bearish momentum divergence and shift the risk back to the downside.

Here's Norway stuck below 905 and making 1-month lows.

And here's an example of an Emerging Market, the Russian Micex, stuck below resistance.

2. The second risk is tied into the first but is looking at US stocks relative to the most liquid alternatives out there...US treasury bonds and gold. Below JC is pointing out that the S&P 500 is failing at resistance relative to both of those alternatives, suggesting that money continues to favor bonds and gold over stocks.

When we have a strong absolute trend in an asset, we also want to see it outperforming its alternatives, which stocks are currently not. This is a significant risk in our view that will only be resolved by these resistance levels being broken to the upside.

In India, we see something similar with the Nifty 50 vs Gold chart in a relative downtrend. We want to see this chart continue to stabilize and push higher as opposed to breaking to new lows and testing support from 2012-2013.

3. The third major risk is interest rates. As we can see above, money continues to flow into bonds at a faster rate than stocks...and this is happening not just in the US, but globally. Just look at any chart of a major economy's Interest Rates...they all look very similar to the US and India.

Since March the US 10-year yield, the "safe haven" benchmark for Interest Rates around the globe, has made no upward progress since March and is now pressing to new lows. In India, the 10-year yield is also stuck below long-term support near 6.20%, both of which are signs that money continues to flow into bonds...which is indicative of the strong risk appetite that's required for a global bull market in equities to occur.

4. Tied into the lower interest rate picture is the performance of Financial stocks. In both the US, India, and other major global markets, Financials are one of the largest weightings of each. Essentially what this means is that it's difficult to have a global bull market in stocks if Financials are not, at the very least, trending higher on an absolute basis. They don't necessarily need to outperform, but they cannot be falling on an absolute basis while the rest of the market heads higher. They are far too important.

Last week JC pointed out to our US subscribers that US Financials are threatening to break down below support on an absolute basis as their relative performance push towards new lows. Not a great sign.

In India, the Nifty Financial Services Index isn't pressing to new lows like in the US, but it's certainly not made as much upward progress as some of the other areas of the market.

Here's the sector on a relative basis stuck below a confluence of former support around 1.00. Bulls really want to see this level reclaimed.

5. Last on our list is Crude Oil, which is a risk-on asset that's just run into former support and the 61.8% Fibonacci Retracement of its 2020 decline near 3,200. With momentum diverging and prices failing to break this level of resistance on their first test, there's now risk to the downside.

If Crude Oil is selling off, that's a negative for equities and other risk assets, so market bulls want to see it consolidate over time as opposed to starting a larger correction through price.

If all of these factors outlined above come into play, then we're likely in an environment where the risk management levels we outlined for Indian Equities are being broken to the downside and a more defensive posture in the near-term is warranted.

Let's quickly review what they are in simple terms:

1. Global equity indices breaking down instead of out;
2. US stocks underperforming their alternatives of bonds/gold;
3. Interest rates in the US and globally pushing to new lows;
4. US Financials making new absolute and relative lows; and
5. Crude Oil correcting through price rather than time.

As you can see, a lot of what happens in India in the coming week(s) is going to depend on what happens in the US.

With that being said, it's important to view these tactical (short-term) concerns within the structural (long-term picture).

As we outlined in our post titled "Reminder: Stocks Go Up AND Down", the weight of the evidence continues to grow in favor of the bulls. Our longs continue to work in this environment and attractive short opportunities remain scarce. Until that weight of the evidence changes, we're sticking with our bullish longer-term outlook.

Hopefully, this post clearly outlined some of the things that we're watching for an early indication that an adjustment to our thesis may be necessary. In the meantime, stick with the risk management levels outlined here for India's major indices as those will be our actual triggers to get more defensive, regardless of what's happening elsewhere in the world.

Thanks for reading and please let us know if you have any questions.

Allstarcharts Team