How does the old saying go? If you play with fire long enough, you’ll eventually get burned? Well, for several days now stocks have been playing with fire. On Wednesday they got burned. They were burned badly enough, in fact, that the market might be forced to move all the way through a full-blown correction.
That’s not the end of the world. Indeed, a good capitulation may be just what we need, clearing the decks for the usual year-end bullishness. The timing for such an event is just about perfect.
But, first things first.
In simplest terms, the S&P 500 slipped into a serious amount of trouble on Wednesday. It had been toying with its 200-day moving average line (green) for several days. With Wednesday’s loss of 1.43% though, it’s now well under that long-term indicator as well as below an important horizontal floor (yellow, dashed) at 4,214. There’s nothing really left in place to stop the bleeding now, except for maybe… well, hold that thought.
The NASDAQ Composite is in a similar kind of trouble, but with one glaring exception. That is, the composite didn’t break under its 200-day moving average line (green) at 12,768. It’s just testing it with Wednesday’s low. The NASDAQ did slip under an important floor at 12,937 though.
Notice that both the S&P 500’s and the NASDAQ’s volatility indexes (the VIX and VXN) are back above their recent technical ceilings as well. This further suggests the tide is turning for the worse. What’s so bearish here, however, is that neither the VIX nor the VXN have raced to unsustainable peaks. This action says traders aren’t exactly panicked here. The selling -- and hedging -- is methodical. That’s why it’s apt to continue.
As was noted though, that may not be a bad thing… given the market’s limited options at this time.
We talk about calendar-based tendencies on a semi-regular basis, but we don’t talk too much about how the market performs over the course of the average four-year Presidential term. We should, however, since these tendencies seem to be a little more reliable than just the annual ones. And, as we head into the end of the third year of President Joe Biden’s first term, things are proceeding about as you’d expect them to. That’s going to be a problem for stocks just a little bit longer.
The graphic below tells the tale, plotting where the S&P 500 is at this point in the four-year stretch versus where it normally would be. Interestingly, although the performance variation can be very wide from a bullish and bearish Presidential term period, weakness around this time of the third-year is actually rather predictable regardless of the bigger trend. Stocks usually struggle all the way through mid-November… even in bullish environments.
This is arguably an idea lead for the current market to follow. A little more selling for about three more weeks would drag the S&P 500 to a complete more than 10% correction, versus its current 9% dip from its late-July peak. The bigger the selloff, the more complete it is because more dead weight is shed.
Just don’t count your chickens before they’re hatched.
It’s been a while since we’ve plotted Fibonacci retracement lines on either the NASDAQ Composite or the S&P 500, mostly because there’s been little point in doing so. Now there’s a need. Wednesday’s lows for both indexes were near-perfect 38.2% retracements of their rallies from last October to this July. This is at least place you’d expect the bulls to make a stand.
That doesn’t inherently mean the bulls will successfully maintain a floor at these levels, spurring a reversal here and right now. It’s just a possibility -- one worth acknowledging. It could take two or three tries in both directions to either break under this floor or push up and off of it. It’s just something to keep an eye on, particularly in the context of everything else going on right now.
That said, also bear in mind if these horizontal Fibonacci retracement labels should fail as technical support, that more likely than not opens the flood gates to a more serious wave of selling. With no other floors left below, that could mean a slide all the way back to the 61.8% Fibonacci lines. That’s 11,759 for the composite, and 3,908 for the S&P 500.
Again, however, maybe one more good capitulatory rout is exactly what’s needed here to start a new, more prolonged bull trend. Look for the volatility indexes to be “spiky” at such a low, which they aren’t right. That’s something aways down the road either way though.