Posted by Scott Brown, CMT, Technical Market Strategist
Thursday, June 2, 2022
Stocks rallied hard last week, as the S&P 500 Index broke a seven week losing streak in resounding fashion; its 6.6% gain was the best since November 2020. That strong response from equities, following one of the worst starts to the year ever, has many investors questioning, “Was that the low?” While we are certainly open to that possibility, today we will take a look at why the technical picture suggests volatility is likely to remain elevated in the near term.
First, let’s take a look at the technical set-up of the S&P 500. While stocks have bounced decisively off important support near 3800, the index is now faced with multiple levels of technical resistance, including broken support from the February and March lows, and the 50-day moving average at 4270. Given stocks steady series of lower highs and lower lows throughout 2022, it is important for us to see evidence that this trend has turned and can hold a higher high.
Second, we remain skeptical that this market has truly bottomed without the capitulatory flush usually found at major market lows, as we discussed in last month’s Weekly Market Commentary. Nothing in markets has to happen, but whether it is put/call ratios, a stubbornly low VIX (a measure of implied market volatility based on options prices), or even just the fact that several of the nongrowth sectors arguably remain rangebound from 2021 and haven’t corrected, it would be highly unusual for us to see such a major market low without genuine signs of investor panic and indiscriminate selling. Of the five major signs of panic that we track and are often found at major market bottoms, only one has triggered so far this year in contrast to a minimum of 3 that have been found at recent lows in March 2020, the fall of 2015, late 2011 and the Great Financial Crisis in 2008-2009.
Finally, while we are inching closer, we remain in the seasonally weak part of the year and a May low would still be on the early side of the average low in a midterm year. Looking at all the midterm years going back to 1950, only two have seen their yearly low before May 19, when the S&P 500 made its closing low two weeks ago. We would note though, that the depth of this correction is almost exactly in line with the average mid-term year pullback. And regardless of when we make that bottom, as the chart below shows, the gains a year after the low have been substantial with a more than 30% average return and only one occurrence falling short of a double digit gain.
“We are anything but market pessimists,” explained LPL Financial Technical Market Strategist Scott Brown. “In fact, we believe there will be substantial opportunity in stocks on the other side of this volatility and likely in the second half of the year. However, outside of this recent rally, very little about this market has changed from a technical standpoint and that makes us wary of calling the all-clear. We believe a slight lean towards defensive sectors and away from the growth-oriented areas of this market still make sense”.
LPL Research’s Strategic and Tactical Asset Allocation Committee is most positive on healthcare and real estate and is becoming increasingly positive on energy. Within growth sectors, we are most negative on communication services and consumer discretionary and also believe the industrials sector is likely to underperform.
To read more on what catalysts could drive a rally in the second half of the year, be sure to check out the latest Weekly Market Commentary.
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