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An oversold bounce or sustainable stock market recovery?

Stocks rebounded on Friday due to the surprisingly robust job market report. The day started with a sharp rise in oil prices and a decline in stock prices as investors reacted to the war between Israel and Hamas. Investors feared the conflict could broaden beyond the Middle East, leading to higher inflationary pressure and jeopardizing a shaky global economic recovery.


However, the afternoon stock market reversal suggests that investors may not be overly concerned about the new geopolitical conflict or are playing a waiting game to determine the risks of the Middle East conflict on global financial markets.


Technically speaking, U.S. stocks, as represented by the S&P 500 Index (SPX – 4,335.66) near a critical phase. The outcome over the near term (a few days to weeks) will help decide the next directional trend.


On a near-to-medium term, the SPX has weakened due to the recent violation of neckline support at 4,328-4,335, confirming the June 2023 head and shoulders top. The bears are adamant that the breakdown signals a market top and the beginning of the next bear market. The head and shoulders top breakdown still renders a downside target of 4,049.09 or close to the Apr/May 2023 lows and the 50% retracement from the Oct 2022-Jul 2023 rally. Under strong selling, SPX may fall toward 3,918 to retest the 61.8% retracement from the Oct 2022-Jul 2023 rally and below this to 3,764.5-3,809 (Dec 2022 and Mar 2023 lows).


On a positive note, despite the market volatility and the summer-to-fall setback of 390.62 points or -8.48%, SPX is still trading above its 10% threshold (4,146.36), placing this downturn as a normal pullback. Most important, is SPX still retains its pivotal support corresponding to 4,181-4,211 (38.2% retracement from the Oct 2022-Jul 2023 rally, May 2023 breakout, the bottom of the Jul 2023 downtrend channel, the 50% retracement from the Mar-Jul 2023 rally, and the 200-day ma).


A deeply oversold condition (RSI traded below 30 in early-Oct), coupled with a positive outside day on 10/6/23 and the ability to find support above 4,181-4,211, gives the bulls hope that this is another consolidation within a structural bull trend.


The key to a sustainable bull market rally remains the integrity of the rebound. After incurring technical damages, the hallmark of a strong and long-lasting bull is the ability to repair the technical damages incurred by building the necessary base to clear above previous key breakdown levels and formidable resistances.


SPX must prove to investors that it has the legs to overcome the Jul-Oct 2023 setback. Although it is technically constructive that SPX has successfully rebounded from pivotal support (4,181-4,211), it is still considered an oversold bounce. SPX needs to convincingly surge above its previous breakdowns, including the bottom of the Oct 2022 uptrend channel breakdown (now at 4,305) and the prior neckline breakdown (4,328-4,335) to substantiate the beginning of a sustainable recovery.


The ability to surge above 4,328-4,335 will allow SPX to challenge secondary resistance at 4,376-4,401 (9/21/23 gap-down) and 4,419.5 (50-day ma). Additional resistances appear near 4,448.5-4,458.5 and 4,476, coinciding with the Jun 2023 highs or the left shoulders and the top of the Jul 2023 downtrend channel. A breakout above 4,476 and preferably above 4,541.25 (9/1/23 negative outside high and the right shoulder) signals a retest of 4,607.07 (7/27/23 reaction high and the head). Above 4,607.07 confirms a rally of 278.99 points to 4,791 (top of the Oct 2022 uptrend channel) and above 4,818.62 (1/4/22 all-time high), and 4,886.06 (h/s top breakout target).


Source: Chart courtesy of StockCharts.com

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