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The start of a late summer correction?

After more than four months of robust stock market gains, it is reasonable to expect corrections. Stock market corrections tend to come out of nowhere, and traders are often surprised when it happens. However, corrections are common occurrences necessary to sustain uptrends as they help alleviate overbought market conditions, preventing speculation from escalating into stock market bubbles.


Here is the good news about the stock market.


The stock market, as represented by the S&P 500 Index (SPX – 4,513.39), remains in a primary uptrend channel from the two lows at 3,491.58 (10/13/22) and 3,808.86 (3/13/23). The current 4-plus month uptrend channel suggests SPX continue toward 4,626-4,650 (May 2023 breakout above 4,195.44 projection and the top of the Mar 2023 uptrend channel), and above this to 4,818.62 (1/4/22 all-time high), 4,906 (accelerated channel breakout above 4,650 targets), and 5,159 (Jun 2023 breakout above 4,325.28 projection).


The sustainability of the SPX rally from the Oct 2022/Mar 2023 lows depends on two developments regarding the two primary uptrends. On a near-term basis, the ability of SPX to maintain above 4,394 or the 50-day ma and the bottom of the Mar 2023 uptrend channel on pullbacks is bullish. On a medium-term basis, SPX must not break down below 4,088-4,134, coinciding with the pivotal 200-day ma and the Oct 2022 uptrend.


Respecting the dominant and prevailing trends via the trend is your friend principle that has kept investors involved in stocks since late last year. Market corrections occurring during the seasonality weakness period from late Summer to early-Fall should not surprise anyone, especially given the speed and magnitude of the recent rallies. Pullbacks will allow traders and investors another opportunity to buy stocks at better levels.


Here is the bad news.


The stock market rally from Oct 2022 and Mar 2023 lows continues to be heavily driven by mega-cap technology names, specifically, the Magnificent Seven stocks. Since SPX, COMPQ, and NDX are market-cap-weighted, the seven tech names can exert undue influence on the near-term trends of these indexes. Two Magnificent Seven stocks (AAPL and AMZN) will report earnings tomorrow after the market. Pay attention to the market response after-hours trading to gauge the impact on Friday’s trading.


SPX, COMPQ, and NDX recorded large daily gap-downs on 8/2/23. The three technology-laden indexes also generated potential bearish island reversals on 8/2/23. On a positive note, many other U.S. indexes, including INDU, TRAN, UTIL, NYA, SML, and IWM, lack gap-downs or bearish island reversals.


Bond markets were volatile due to the Fitch downgrade of the credit ratings of US mortgage giants Freddie Mac and Fannie Mae from AAA to AA+ due to uncertainty about the U.S. government fulfilling its debt obligations and concerns about the housing government-sponsored enterprises (GSEs).


It is crucial to closely monitor the 10-year U.S. Treasury Yield (TNX) as it nears critical resistance at 4.091-4.094% (3/2/23 and 7/7/23 island reversal highs). The ability of TNX to rebound from the 50-day ma (3.816%) and 200-day ma (3.710%) and a recent golden cross buy signal (7/13/23) suggest another uptrend in U.S. interest rates. A breakout above 4.094% signals a retest of the reaction high of 4.333% (10/21/22). Above this reaffirms the 1982 structural downtrend breakout and a long-term structural uptrend. Higher interest rates will likely hurt stocks, specifically growth-related names, including the Magnificent Seven.


Forecasting a market correction remains challenging. Predicting the extent is as difficult. It does not help that the stock market has rallied sharply this year and is entering the seasonality weakness period. So far, the market has been resilient and has confounded the bears.


Based on the impressive gains, a 3-5% correction can occur anytime. A correction of 5-10% is also possible. However, generating a deep or more extensive market correction exceeding 11% would likely require a crisis or an adverse event.


Below is a summary of the technical support levels for the SPX Index.


S&P 500 Index (SPX – 4,513.39)


Initial support = 4,394 (50-day ma and the bottom of the Mar 2023 uptrend channel) or -213.07 points (-4.62% from the 7/17/23 high of 4,607.07)


Secondary support = 4,325-4,328 (6/12/23 breakout and 6/26/23 low) or -279.7 to -282.07 (-6.06% to -6.12%)


Medium-term support = 4,195.44 (5/30/23 breakout) or -411.63 (-8.93%)


Intermediate-term support = 4,088-4,134 (200-day ma and the Oct 2022 uptrend) or -473.07 to -519.07 (-10.27% to -11.27%)


Source: Chart courtesy of StockCharts.com

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