Enjoy the stock market's rally — but watch out for these overbought indicators

Lawrence G. McMillan maintains a bullish yet vigilant outlook on the S&P 500, citing continued strength, positive market internals, falling put-call ratios, and declining realized volatility. However, he highlights increasing overbought conditions, notably a new McMillan Volatility Band (MVB) sell signal targeting SPX at 6,030, and notes that equity-only put-call ratios are now in overbought territory. The analysis advises enjoying the current rally while remaining wary of these emerging signals, recommending a specific put spread based on the MVB signal.

Analysis

The current market landscape for the S&P 500 presents a duality of a strong primary uptrend alongside mounting evidence of overbought conditions, warranting a cautiously bullish stance. Key bullish indicators remain intact: the S&P 500 chart is strong, equity-only put-call ratios continue to fall, new highs on the NYSE are outpacing new lows, and the Cboe Volatility Index (VIX) remains subdued near 17.0 and below its 200-day moving average. However, countervailing signals are emerging, most notably the first confirmed McMillan Volatility Band (MVB) sell signal, which targets a pullback in the SPX to 6,030. This is compounded by other overbought readings, such as low put-call ratio levels and a 20-day historical volatility (HV20) of 9%, which is approaching the 8% level that would constitute a sell signal. Furthermore, market breadth oscillators are showing divergence, with the NYSE-based indicator flashing a sell signal that was not confirmed by the 'stocks only' oscillator, indicating a lack of broad conviction for a downturn. The analysis suggests that while the primary trend is positive, the risk of a near-term correction has increased significantly, shifting the strategy from pure bullishness to active risk management.

Key Decisions for Investors

• Investors should consider hedging long equity exposure to protect against a potential pullback, as suggested by the first confirmed McMillan Volatility Band (MVB) sell signal.
• Monitor key S&P 500 technical levels, as a close below support at 5,920 would confirm a bearish reversal, while a sustained move above resistance at 6,300 would negate the current sell signals.
• Watch for a close in the VIX above its 200-day moving average or a drop in the 20-day historical volatility (HV20) to 8%, as either event would serve as a strong confirmation of a pending market correction.
• Selectively manage single-stock positions based on their specific technicals, such as considering the conditional call buy on DocuSign (DOCU) if it closes above $80, while divesting from positions like Baker Hughes (BKR) where put-call ratios have generated sell signals.