S&P 500 - Back To Key 1,850 Level

Includes: SPY
by: Dean Popplewell

By Mingze Wu

Welcome to Bizarro World, where everything is inverted - up is down, left is right, black becomes white, and good economic news actually sends prices tumbling!

S&P 500 suffered the largest daily loss in 5 weeks, shedding 1.17%. This decline is not limited to S&P 500, with Dow Jones Industrial Average closing even more bearishly at -1.41% while the risk sensitive Nasdaq 100 lost 1.51%. As the losses are seen across the board, we can safely say that risk appetite is bearish, but unfortunately the reason for this capitulation of risk appetite is not apparently clear as all the US related economic number releases were actually better than expected.

Case in point, US Advance Retail Sales grew 0.3% versus 0.2% expected, while Initial Jobless Claims and Continuing Claims were also below expectations. Monthly Budget Statement of the American Government also reflects a narrowing budget deficit - good news for everybody. In fact, looking at the hourly chart we can see that US stocks actually traded higher initially when market opened at 9.30 am (9.30pm on SGT Chart below).

Hourly Chart

So what happened? Headlines today point to the ongoing Ukraine crisis and weak Chinese data as culprits for the decline, but neither are good explanations. Firstly, we did not have any new developments on Ukraine yesterday, and even though any escalation of the current standoff in Crimea is definitely bad for the markets, stock prices actually traded higher on Wednesday even though the same Ukraine crisis was happening. On the topic of Chinese data, S&P 500 Futures prices were actually relatively stable when the lower than expected Industrial Production and Retail Sales numbers were released, with prices mostly staying above 1,870 soft support. Factor in the initial bullish push in US stocks during the opening hour mentioned earlier and it is clear that Chinese numbers were not really that damaging to risk appetite.

Hence, we are left with overstretched bullish sentiment as an explanation for yesterday's decline. This may sound like a cop-out, but there is some justification for this as stocks have been considered overvalued by many analysts with economic growth numbers not justifying such premiums. Furthermore, from a momentum perspective, we've yet to see any significant bearish pullback in current bullish run up and to say that stocks are overbought now is not only a fair statement but may even be putting it rather mildly. If this analysis is true, then the market is at high risk of reversing lower and it is not surprising to see traders getting a little bit jittery and selling stocks when there are signs of weakness. In yesterday's case, the signs of weakness could be the failure to break the upper wedge, and things started to cascade down from there.

Daily Chart

The more important question that we need to ask is what next? Looking at the Hourly Chart above, prices have climbed back above the 1,750 round figure but remain below the lower wedge, hence the directional verdict is still out. Daily Chart show signs of bearish bias with Stochastic readings currently amidst a bearish cycle but preferably a confirmation of an 1,850 break should be sought in order to negate current bullish momentum.

Fundamentally, on top of less than stellar economic growth numbers, current stock prices also face huge downside risks as these prices have been inflated by new record lows of leverage (e.g. borrowed money). By trading on leverage, traders will be more cautious moving forward as the amount of losses they can stomach is lower and we could see more of yesterday's behavior happening in the future. That being said, this is simply one school of thought and it is almost equally likely that current lower prices may encourage even more borrowing and more purchases to take advantage of "bargain prices".

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.