Three Tactical Rules Flash Yellow for Stocks

Dan Zolet of ETF Strategist, in a July update, reported the Three Tactical Rules are a flashing yellow light. The update links lower inflation readings, a likely Federal Reserve pause, slowing market trends and mixed investor sentiment.

June’s headline CPI was 3.5% and core CPI was 2.6%. Fed funds futures indicated the Fed was likely to hold rates at the July 29 meeting while pricing a 25 basis-point increase later in the year. The update noted Federal Reserve Chair Warsh has emphasized price stability. Brent crude traded above $80 per barrel after renewed tensions between the U.S. and Iran.

Since the prior Three Tactical Rules update on June 9, the S&P 500 rose by less than 1%. The index’s 200-day moving average was rising at a 17% annualized rate, down from 23% in the previous update. Short-term momentum eased during that period, largely driven by a pullback in AI-related stocks. The update cited historical data showing the S&P has produced positive returns about two-thirds of the time over any three-month span.

International equities also slowed. The MSCI All Country World ex-US index’s primary trend rose at a 22% annualized rate, down from 29% previously. Over the last seven weeks international stocks underperformed U.S. equities by roughly 0.5%, narrowing their year-to-date advantage to about 2.9%.

Investor sentiment readings were mixed. Ned Davis Research’s Weekly Sentiment Poll remained in an extreme optimism zone while the Daily Sentiment Poll sat in a neutral range. The update explained the Weekly poll relies more on surveys, while the Daily poll incorporates market measures such as put/call ratios and volatility. Blending the two placed crowd optimism between the upper end of neutral and the lower end of extreme optimism, and the Crowd rating was upgraded from flashing red to yellow.

Overnight Index Swap markets priced at least one rate increase this year for the Bank of England, the European Central Bank and the Bank of Japan. The update said further delays in resolving the Iran conflict could prompt additional tightening by major international central banks.

The July update kept the three tactical rules — Fed, Trend and Crowd — collectively at a flashing yellow light. The update noted the ratings were unchanged from the prior report and that data and geopolitical developments could cause the rules to change in the coming weeks.