The S&P 500 fell approximately 40 basis points on Monday, with technology stocks leading the decline according to reports from Investing.com India. Technical analysis reveals the index is consolidating and may be forming a diamond pattern. The analysis indicates there appears to have been a widening formation leading into the June 2 peak, followed by the current consolidation phase, which is consistent with a diamond top pattern formation. Wall Street veteran Jim Paulsen, former chief strategist at The Leuthold Group, warns that "several indicators now suggest the stock market is substantially extended and could require some period of consolidation." His analysis suggests the market may be headed for a 20% correction in the near future, though he notes the AI trade could rally further before stocks decline.
The falling RSI suggests that momentum has faded significantly over the past several weeks and has yet to recover, as reported by Investing.com India. This technical signal is viewed as negative for the index, with both the Nasdaq 100 and S&P 500 spending the past several days consolidating. The trading ranges continue to tighten, and the wedge appears to be nearing completion, suggesting that a breakout in either direction could be approaching. Paulsen notes that "the stock market looks to be running ahead of the US economy, largely due to growth in what I've dubbed 'New Era' stocks." Information technology stocks in the S&P 500 are up 33% this year, outstripping the 10% gain in the broader index, according to State Street Investment Management.
2-year Treasury yields rose on the day despite falling oil prices, climbing to roughly 4.25% according to Investing.com India analysis. If the 2-year yield has indeed broken out of the bull pennant highlighted on the chart, the measured move projection would suggest a rise toward 4.4%. The Dollar Index continued to strengthen, having broken above resistance at 100.50 last week and now trading north of 101. If the pattern is similar to the bull pennant seen in the 2-year yield, the measured-move projection would suggest the Dollar Index could extend its rally toward 103.40. Such movements would likely reinforce the recent tightening in financial conditions and could present additional headwinds for equities.
Markets are flashing signs that economic policy is becoming more restrictive, which could hurt stocks according to Paulsen's analysis. The federal budget deficit amounted to 5.7% of GDP last year, down from a peak of 14.4% during the pandemic, according to data from the US Office of Management and Budget. Real GDP growth attributable to investment spending on new-era companies has risen to 8% year-over-year, compared to the broader 1.1% average yearly growth across the rest of the economy. Paulsen warns that "the divergence between the stock market and liquidity levels in the economy are getting more extreme and concerning." The percentage of US corporate and household cash relative to GDP has plummeted in recent years, though the S&P 500 has continued to push higher.
The S&P 500 has remained close to record-highs, but consumers are feeling worse about the economy, breaking a long-running relationship between stocks and sentiment on Main Street. Paulsen points to the University of Michigan's measure dropping to an all-time low in May, as reported by The Leuthold Group. This divergence between benchmark index performance and consumer sentiment represents "another sign that perhaps the stock market's recent run may be getting a bit extreme." The percentage of investors' portfolios allocated to stocks is currently hovering around levels seen before the dot-com bubble burst, with the measure at almost 55% according to survey data from the American Association of Independent Investors. Since 1988, whenever this allocation nears or exceeds 50% of portfolios, the stock market has often struggled.
