U.S. stocks followed up their impressive first quarter with another month of healthy gains in April, but the returns so far have many investors wondering how long the party can last.
Tony Dwyer, equity strategist at Canaccord Genuity, weighed in on the question in a Tuesday research note, writing that, after the S&P 500 index
has gained more than 17% year-to-date, “the tactical backdrop continues to suggest a minor correction in the near term, with any drawdown limited to 5%”
Dwyer based his call for a pullback on what he describes as “near extreme overbought/optimism levels” within the S&P 500, as the evidenced by the 14-week stochastic indicator, which measures the weekly price of the S&P relative to its highs and lows over the past 14 weeks. The gauge is used to help time turns in the market.
Also supporting his thesis is that, after Feb 15, when 90% of S&P 500 components had surpassed their 50-day moving averages, the median stock in the index rose 5.1%, well above the historical norm. This level of market breadth is typically a contrarian indicator, signifying that stocks are overbought.
Finally, Dwyer argued that in the current earnings season — wherein 77% of the S&P 500 have beaten earnings estimates, while revenue growth is on pace to a “respectable 5%” — the fear of an earnings recession has evaporated, helping power the index’s 3.6% climb in April. “That leaves us with less skepticism ahead of a plethora of economic data that is likely to show further slowing.”
This burst of optimism before what Dwyer predicts will be downbeat, U.S. economic data releases sets the market up for a mild pullback in the weeks ahead, he wrote.“Any pause in the upside should prove limited and temporary,” he went on to argue, as dovish central bank policy and the stabilization of global growth should support stock prices in the medium term.
“Our 2019 S&P 500 target of 2,950 may prove conservative,” he wrote. “And we would view a 3-5% pullback as an opportunity to add exposure in the Info Tech, Financial and Industrial sectors.”
Providing critical information for the U.S. trading day. Subscribe to MarketWatch’s free Need to Know newsletter. Sign up here.