As I type this the S+P 500 is down about 11.50% from it’s highs. All four major market averages are below their 50 and 200 day moving averages. And the cumulative advance – decline line is also below its 50 and 200 day moving averages. A caution sign if there ever was one, as it has been about four years since we last saw this level of volatility. Let’s take a look at the technical scenarios to look for in the days and months ahead.
The chart above shows trading in the S+P 500 since the 2011 correction. That correction caused a drop in the S+P 500 of 295 points or 21%. After the smoke cleared, the S+P would increase 100% over the next four years.
On the way up there were six minor corrections that were all in the 120-150 point variety, with the exception of the fall 2014 correction that happened to be 199 points. That pattern has broken after the dismal August performance in equities. But there is reason to believe we may be nearing a bottom, at least in the short term.
We talked about the potential of revisiting the August lows, and it appears that is what the market is attempting to do. However, there looks to be a confluence of support between 1820-1850. As there is a prior swing high at 1850, 1838 would match the size of the 2011 correction (295 points) and the fall 2014 swing low @ 1820. I have no idea if the final low will come in this vicinity, but I am anticipating some buying reaction here. Given the macro environment, I believe this is the more probable outcome.
However it’s always good to be prepared for multiple outcomes. So in the case that the market spends much time below 1820, I would have to conclude that a full 20% correction would then be the most likely scenario. This would equate to about 1700 on the S+P 500. We have a swing high in the 1680 area and the 2000 and 2008 bull market tops between 1550 – 1575 could be a likely target if this scenario were to play out.
I would say the majority of the concern is coming from lack of earnings growth. Earnings for the 3rd quarter are estimated to fall 4.5% amidst global growth concerns. If this were to occur, it would be the first time since 2009 that earnings declined in back to back quarters. Couple that with the concern of rising short term rates into a weak earnings cycle, and you have a recipe for volatility and contraction.
Since I also believe there is low risk of recession in the near term. I believe that this recent earnings losing streak will eventually dissipate. At the very least I think it’s unlikely that we see the high level of Earnings contraction that accompanies a recession. And if we are to believe that the Fed will take a very modest and gradual approach to raising rates, it is likely that equities will soon find solid footing once.
Without QE it’s possible we don’t see the level of equity market gains that we have seen in the past. But that doesn’t mean that investors won’t be rewarded either.
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