From 12/3/19 to 1/22/20 SPX rallied sharply gaining 267.44 points or +8.71% suggesting an overbought market condition. Although many investors blame the coronavirus for the recent 1/22/20 to 1/31/20 correction (-3.69%) there were technical divergences occurring in advance of the coronavirus news.
From a macro perspective, US interest rates (yields) were declining in front of stock prices setting all-time highs. US Dollar Index were also rallying. This often warns of global risk aversion. Commodities prices including WTI Crude Oil and Brent Crude Oil were falling precipitously for months. The fear indicator or the VIX Index fell to historical lows and were vulnerable for a sharp bounce. Investment sentiment surveys and consumer confidence numbers traded to bullish levels.
In addition to the above technical conditions, a head and shoulders (h/s) top has quietly developed in S&P 500 Index (SPX). Although we remain bullish on an intermediate-to-longer term technical perspective, SPX volatility is likely to expand over the near-term (i.e., 1-3 weeks).
The recent SPX correction to 3,212.03-3,324.68 established key neckline support. The rally on 1/29/20 to 3,293.47 created a right shoulder. Since the height of the technical base is 125.74 points, a convincing move below neckline at 3,212.03-3,234.68 confirms a 1-month h/s top breakdown. This warns of SPX downside targets to 3,151-3,172 (Dec 2019 breakout and the 61.8% retracement from Dec 2019 to Jan 2020 rally). Violation of this support zone opens the door for a deeper correction toward 3,070-3,089 (12/3/19 low and h/s top breakdown target). This would translate to a -4.97-5.60% to -7.45-8.01% correction.
A brief review of the 6 corrections over the past year is interesting. If we undergo the above corrections this would suggest SPX would approach the 3 larger corrections including the 5/1/19 to 6/3/19 correction (-7.63%), 7/26/19-8/5/19 correction (-6.8%), and 9/19/19-10/3/19 correction (5.49%). It is important to point out that if risk aversion increases and selling expands into the decline then SPX can revisit major support along its 200-day ma and its Jun 2019 uptrend at 2,979-3,014. This would result in a correction of -9.70% to -10.75% putting SPX within the threshold of a deep correction that borders on a bear decline.
On the upside, to confirm a bottom and the resumption of the primary uptrend, SPX needs to clear above key initial resistance at 3,293.47 corresponding to the 1/22/20 high and the right shoulder. Trading above this will lead to a retest of the 1/22/20 high and head at 3,337.77. Trading above the prior record high, signals the next sustainable intermediate-term bull rally.