Stocks Are Tumbling Again. Where the S&P 500 Might Be Headed Next.

view original post

Traders on the floor of the New York Stock Exchange.

Michael M. Santiago/Getty Images

The stock market is getting crushed again. The chances that it revisits its recent bottom are greater now. 

The S&P 500 is experiencing its fourth consecutive day of declines Friday. It’s now down about 13% from its mid-August peak of a summer rally. One major driver: Stubbornly high inflation is pushing the Federal Reserve to lift the federal-funds rate at a rapid pace. This week, the Fed indicated that it sees the “peak” fed-funds rate surpassing 4.5%, a little higher than previously anticipated. The Fed is trying to lower the rate of inflation by reducing economic demand, so the problem for the stock market is that the economy could take a hit—and so could corporate earnings.

This all has landed the market at a dangerously low level. The S&P 500 this week fell below a level a bit higher than 3800—it’s now at a tick below 3700. That’s key; at just over 3800, buyers had recently stepped in a few times to prop the index up. Those buyers have gone away because confidence in the market outlook has faded. With the index now in more of a downtrend, “the failure to hold [3850] is a major change of character for the market, increased the odds of a rapid drop to the June lows,” wrote John Kolovos, chief technical strategist at Macro Risk Advisors, in a research report.

Speaking of that June low, the market sure is flirting with revisiting it. The intraday low for the year is 3636, hit in mid-June. The possibility that the S&P 500 goes back to that level is scary not only because it represents a small loss from here, but also because traders would have to hope at that point that it can get buying “support” there. If the index falls below that support level, the next support level is roughly just under 3500. That represents about a 5% loss from here. 

That’s the bad news, but don’t give up hope yet. There’s still an upside scenario. If the index can find support near the low, it could experience an “impulsive rally” past the 4100 area, Kolovos wrote. That’s where a brief early-September rally ended—and sellers stepped in. Buyers at that level would signify a market growing more confident.

Indeed, there could be some positive developments to send the market back upward. The main development would be that the Fed doesn’t actually lift the fed-funds rate to above 4.5%. Historically, the Fed often does not lift rates all the way up to its projection, Sevens Report Research noted. In 2015, the Fed projected that the fed-funds rate would get up to just over 3% a few years from then. By 2019, it peaked around 2%. That’s because interest rates move higher as the Fed’s rate-hiking campaign gets under way, which reduces borrowing and spending. Then, economic growth declines and the Fed pauses on rate hikes. 

“If the economy starts to slow meaningfully in the coming months, history implies that the Fed will…have to lower its expectation of terminal fed funds,” wrote Sevens Report’s Tom Essaye. 

That would likely put a floor under economic growth forecasts. Earnings, while taking a hit, might not tank to catastrophic levels. The market can then look ahead to better days, when economic and profit growth could be reliable. 

The point is that the market is at a crossroads and the next few days of trading will be key. 

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com