As we discussed in earlier this week in Markets Due for a Pause, there were multiple technical reasons to believe that US equities were due for some sort a pullback following a more than 30% rally from the March 23 lows. Technical resistance near the 2935 level for the S&P 500 Index, declining participation, and seasonal headwinds all suggested a near-term downward bias.
On Tuesday and Wednesday, the S&P 500 pulled back more than 3.5%, and closed below its 20-day moving average for the first time since April 3. So where do we go from here?
We would first state that our base case is not for a full retest of the March 23 lows. However, following the initial spike off major historical market lows, a correction of around 10% has been common. A 10% correction from last week’s highs happens to fall almost exactly at 2650, a key area of technical support marked by the green line on the LPL Chart of the Day.
In addition, while the percent of individual stocks above their respective 20-day moving averages has fallen considerably over the past month, because the indicator is so short-term, we believe it may need to fall further before it can be considered oversold.
“Stocks were quite extended following their record run in April, and lower returns have historically accompanied the summer months,” explained LPL Financial Senior Market Strategist Ryan Detrick. “However, we believe a correction could present the buying opportunity that better aligns stock prices with the challenging economic outlook.”
We will continue to monitor technical market indicators as new data comes in, but we believe investors should be paying attention to the performance of the financials and industrials sectors in the coming days and weeks. These groups do not necessarily have to lead the market higher, but many of these stocks topped out two weeks ago contributing to the poor market breadth, or participation cited above. They will likely need to stabilize before the broad market can continue higher.
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