In our last Broad Market Report titled, Historic Uncertainty Meets $7 Trillion Dollar Debt Wall: What Comes Next For The S&P 500, the S&P 500 was trading near 5800 and still well below its February high. We outlined the unique macro risks that were dominating investor sentiment, which were at historic extremes. At the same time, technical signals suggested a path to new all-time highs remained likely
“The market breadth, Q1 earnings beats, and the size of this rally suggest that new all-time highs are likely to follow; however, one cannot underestimate the unique risks within the backdrop of markets.”
Since then, the S&P 500 has surged through overhead resistance, validating many of those technical setups. In fact, the market largely ignored the unique macro risks, many of which are still present.
This is why we continue to lean into technical analysis to guide our positioning: even a sound macro thesis can be overruled by market trends and patterns that are in play.
That said, sentiment has now shifted in the opposite direction—toward euphoria. With tariffs de-escalating, policy shifting toward growth, and risk appetite soaring, we’re beginning to see signs of overheating that have historically led to healthy corrections.
Just as we outlined in our free October and February reports, our base case called for elevated volatility—but with the expectation that it would be buyable. That thesis is once again coming into focus. If the upcoming correction holds above critical support, we believe it will set the stage for another exceptional buying opportunity.
Why We’re Watching Market Breadth Closely as Divergences Resurface
Market breadth remains one of the most dependable ways to assess the strength of a trend. When the S&P 500 makes new highs without confirmation from key leadership—such as semiconductors or the Mag 7—it typically signals a weakening advance.
We used this exact framework in late 2024 in our report, “AI Stocks Signal A Correction Before A Buying Opportunity Emerges,”AI Stocks Signal A Correction Before A Buying Opportunity Emerges,” when we shifted to a defensive posture ahead of a multi-month drawdown. At the time, participation narrowed as the index climbed—something we’re seeing again now.
“While the market continues to push higher, it has been doing so without the support of key stocks and sectors. Unless that divergence resolves to the upside, it tends to be a warning.”
That warning is back. The S&P 500 has notched new highs, yet several of the most important confirming indices are missing in action. Of the eight leading markets we monitor for confirmation, seven are currently diverging from the index:
- Equal-Weighted S&P 500
- Small Caps
- Semiconductors
- High Beta Growth
- Financial Conditions Index
- Transportation Stocks
- CBOE Volatility Index (VIX)
- Advance-Decline Line
Each of these has a strong historical track record of leading turns in the broader market. The Advance-Decline Line, in particular, tracks market participation—and it's deteriorating as the index rises. This shrinking participation is statistically rare and often precedes meaningful pullbacks.
Equally critical is the behavior of economically sensitive areas like Small Caps, the Transportation Sector, and the Equal-Weight S&P 500—all of which tend to lead in and out of market corrections. The Semiconductor sector, meanwhile, is ground zero for the AI hardware boom and arguably the most important sector in the current cycle. None of these are confirming the S&P 500’s breakout.
We’re also watching the VIX closely. While volatility typically declines as equities rise, it tends to tick up in tandem with the index just before major turns. That’s exactly what we’re seeing now—a non-trivial development that deserves attention.
The above markets have a long history of leading market turns. The Advance Decline Line measures market participation, which is shrinking the higher the market goes. This is a rare signal that should not be ignored.
The Equal Weight S&P 500, Transportation Sector and Small Caps, for example, are more economically sensitive, so tend to lead the broad market in and out of corrections. The Semiconductor sector is the most important broad sector in this bull market, as it is where the dominant AI hardware stocks reside. All of which are not confirming the S7P 500’s push to new all-time highs.
The Vix is a measure of expected volatility over the next 30 days. When the market goes up, it goes down. However, just before market turns, we’ll see this index move with the S&P 500, which is exactly what is happening today.
The Mag 7 Leadership Is Fading
The only market that is trending higher with the S&P 500 is the equal-weighted Mag 7. History will remember this bull market as being led by the Mag 7, which are the mega-cap growth stocks involved in the current phase of the A.I. trend – Nvidia, Microsoft, Meta, Google, Amazon, Tesla, Apple. Although material AI monetization is more nuanced, this group has consistently served as a proxy for the health of the bull market.
However, if we look under the hood, out of the seven market leaders, only 3 have made it past their 2024 highs – Nvidia, Meta, Microsoft. The rest are either rangebound or in active downtrends. This lack of broad participation raises the likelihood of a near-term pullback.
As of July 2025, the only Mag-7 that are above their 2024 highs are Nvidia, Microsoft, Nvidia.
It’s important to clarify: not every breadth divergence leads to a correction. However, every major correction begins with weakening breadth. If these divergences continue, the market is more likely to follow the path of its weakest links. On the other hand, if all eight of the non-confirming indices begin to reverse higher, it would likely result in a powerful trend continuation.
This is why we don’t act on breadth signals in isolation. Instead, we combine them with a rules-based checklist of additional clues that help confirm a potential reversal. For now, the weight of evidence is tilting defensive—just as it did in late 2024.
Stock Market Is Extremely Overbought
When evaluating overbought conditions, many investors default to the Relative Strength Index (RSI)—a widely used momentum gauge. While RSI has merit, its most common interpretation (readings over 70 indicating “overbought”) can be misleading in strong market environments.
In strong uptrends, RSI can remain above 70 for extended periods. De-risking solely based on that threshold often leads to premature exits—and missed upside. For example, in the chart below, derisking when RSI first hit 70 would have left an additional 11% of upside on the table.
The RSI is not the best indicator to gauge overbought/oversold levels, as it tends to hit extremes in the middle if a trend, not the end.
For this reason, I prefer the Margin Risk Indicator developed by WealthUmbrella, which identifies the stages of risk within a trend. For one, it has a more robust set of inputs, including: momentum, the slope of the trend, options market positioning, breadth and volatility.
When this indicator moves above 11, it tends to warrant caution, as the market risk is elevated and ripe for a pullback. Any reading over 12, and especially over 13 is considered extremely overbought. It is rare that the indicator stays in this overheated reading for long, signaling that the market is close to a pullback. Unlike the RSI, this indicator tends to trigger closer to the end of a trend, as shown below.
The WealthUmbrella Margin Risk Indicator is a much better tool for gauging overbought/oversold conditions than the RSI, as it tends to trigger closer to the end of a trend.
Today, the reading is at a rare 13, which has only happened less than 1.5% of trading days since the 2009 low. On average, when this reading flashes, the market only has between 1-3% more upside before seeing a correction.
The WealthUmbrella Margin Risk Indicator is flashing a rare 13, signaling an extremely overbought market, and tends to precede trend changes.
Fund Managers Are ‘All-In’ as Cash Positions Hit 12-Year Lows
These overbought conditions are also showing up in fund manager positioning. The most recent Bank of America’s Global Manager Survey saw the biggest spike for risk over the last 3 months on record. The current cash levels, as of July 15th, is at 3.9%, which is the lowest cash position in over 12 years, signaling that investors are, once again, all in on stocks.
This doesn’t mean a crash is imminent. But it does mean risk is rising, and returns are likely to compress in the near term. When signals like this cluster with breadth and sentiment extremes, we begin to prepare—not predict—for a market transition.
Stock Market Warning Signs Align with Broader S&P 500 Analysis
Below are the levels we are watching that will confirm if the market is headed lower – and by how much. We use these levels to hedge our portfolio and to help protect our gains – which is what we did near the top in early January and again in February. We also use these levels to buy back lower – which is what we did in April and March when we entered 20 tranches.
We won’t always get it right, nor is that the point. The point is to protect our money to to the best of our ability through risk management. Sign up below for free to receive the SPX levels we are watching.
Subscribe for Free Below to see our updated game plan, which includes:
- The most probable path we expect equities to take through the second half of 2025.
- The key levels that must hold to keep that path in play.
- And what our strategy becomes if those levels fail.
One of these scenarios is starting to take shape — read this timely analysis below.
The risks worth mentioning in the S&P 500 are mounting. For one, it is just below a major trend line. This trend line, which marked February's peak, now serves as significant resistance.
Another point worth mentioning is how the bounce in the S&P 500 off the April low is now trending higher on less volume and momentum. On nearly every chart that we track, the higher we go, the less enthusiasm is being shown with buyers, which almost always precedes a trend change.
Furthermore, the RSI is just under the bear market resistance zone. When the RSI is below this region, and price is at new highs, it is a warning. In powerful market moves, which tend to be in the middle of a trend, we will see this region break to the upside and oscillate around this zone. This has yet to happen. A failure at this region historically leads to sizable corrections.
The I/O Fund’s general outlook for the broad market into 2025 and 2026.
As long as the market remains above 6200 – 6105, we can continue to drift higher. Below these levels will signal a top, of sorts. Once this happens, there are two general scenarios that best fit the price patterns:
- Green – This is the most probable scenario based on the perceived price pattern. We are in the final 5th wave of the cyclical bull market that started in 2022. The pattern of this bull market is a diagonal pattern, which means the coming correction will be an overlapping/3-wave drop that holds over 5345. We will then see a final multi-month swing to new highs.
- Blue – This is the next likely scenario. Here, the market gave us a rare and extremely shallow B-wave correction. As B-waves are the most variable wave pattern within Elliott Wave, we have to account for this. In fact, the same rare occurrence happened in late 2024. In this scenario, we would see a minor correction back to 6200, yest hold this level. Then we would continue to grind higher toward 7200 into this Fall.
- Red – While I do not have this as I high likelihood, the price patterns allow for this to unfold. Here, the cyclical bull market that started in 2022 ended in February of 2025. The current bounce is a correction within a larger drawdown. This means the next drop will be a more aggressive/5-wave drop that breaks through 5920, 5768, 5645, 5515, and final 5345. Each level that breaks, the higher risk will become. If this happens, then we will exceed the April lows before finding meaningful support.
In conclusion, while we do not believe a market crash is the most probable scenario, it should be acknowledged considering the market pattern allows for it. Regardless of what we expect, the market is the greatest predictor of future events. We do intend to let the market tell us what to do in the coming correction.
Since the April lows, we have maintained our original game plan – reposition defensively into the bounce and let the market tell us what the next move will be. In other words, if the next pullback is a messy/3-wave drop, we will position aggressively for the next trend higher. If instead we see an aggressive/5-wave drop, we will patiently wait for lower levels to position.
Even though we were very defensive going into this year, we were quite clear in October and February that any volatility would be bought. Within our premium subscription we issued 22 buy alerts between March 3rd and April 7, with 12 of those buy alerts happening between April 4th – 7th. We do not know many out there that were buying these lows as aggressively as we were.
Today, we are echoing the same game plan that we outlined in February – the market is, once again, setting up for a correction, the nature of which will likely set up another excellent buying opportunity.
If you have missed out on the A.I. trend, are afraid it’s a bubble, or are not sure how to get involved, we encourage you to attend our upcoming weekly webinar for premium members. Next Thursday, August 7th, at 4:30 ET. In this upcoming webinar, we will discuss our game plan regarding the remainder of 2025. We will list buy targets for great AI names as well as go over how we plan to raise cash and further hedge our portfolio if this bear market continues into 2026. Learn more here.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
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