After reaching an extreme oversold level on Christmas Eve, the market has been trending higher for the last few weeks. Yes, there have been sharp declines on a few days, but the overall trend has been to the upside. Now that stocks have rallied back, the S&P 500 is set to face its first real test.
Stocks were due for a rally after the sharp drop in December. Stocks had sold off so badly that after the big drop on December 24, there were 479 members of the S&P 500 that were in oversold territory based on having daily stochastic readings below the 20 level—the traditional demarcation point of oversold territory.
I have been running the scan for S&P members in oversold territory for a number of years and had never seen such a high number of stocks on the list. So the rally since then hasn’t been a big surprise to me.
Over the last few days though, the rally seems to be losing a little steam and so I ran the opposite scan last night—S&P members with daily stochastic readings above 80. That is the traditional demarcation point for oversold readings. At the close on January 9, there were 277 members of the S&P with stochastic readings over 80 and there were only seven members with stochastic readings under 20. Not quite a total reversal of fortune, but a substantial change in the indicators.
Now that stocks have bounced back, the S&P will face its first substantial resistance on the climb back up. You can see on the chart below that the 2,600 area served as support after the drop in October. It was also the 2,600 level that served as support in the second quarter and to some degree in the first quarter. The index did drop below the level in the first quarter, but there was only one week where it closed below that level.
The 2,600 level is also key for a second reason—the 104-week moving average is sitting at 2,603.02 currently. I have written extensively about how stocks behaved before, during, and after the bear markets in 2000-2002 and 2007-2009. The 104-week served as resistance in both of those time periods.
What is very interesting about the S&P possibly facing its first challenge is the fact that earnings season starts next week. I wrote about possible concerns with earnings season earlier this week. One plus is that expectations seem to be lower heading into this earnings season, but I am not sure if that is going to be enough to help.
With the trade war still going on, companies are going to be issuing guidance based on current circumstances. Without an agreement between the U.S. and China, we could see companies match or beat on the current estimates, but then issue disappointing guidance.
I specifically mentioned the industrial sector in the earlier article, but it isn’t the only sector that is reliant on trade to meet their numbers. Almost all sectors will be impacted if the trade war continues, with certain ones being more vulnerable—tech being one in particular.
The government shutdown is now going on its third week and it could also impact the guidance for certain companies as we move forward. The shutdown won’t have an impact on fourth quarter results, but once again the guidance could be a major concern—especially for consumer oriented stocks.
I encourage investors to exercise caution and patience as we move forward. If the moving average acts as resistance as it did in the two previous bear markets, the market will turn lower once again. If the S&P is able to move back above the resistance level and start a new upward trend, you will have time to get back in.