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Stock Bulls May Be Showing Fatigue

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May 3, 2016
sp500 retracement support

Markets don't move in a straight line up or down forever. In a trending market, pullbacks, pauses and retracements are normal, and generally considered healthy market occurrences. In the wake of the stunning rally off the February low, last week's action in the S&P 500 has some analysts concerned that the broader stock market may be revealing some bullish fatigue. 

Lofty Price Levels?

Throughout February and March, the S&P 500 rebounded strongly from its first quarter 10.5% decline to the February 11 low at 1,810, surging back to the 2,110 zone on April 20. The index stalled just shy of the November 2015 peak at 2,116 and the all-time high at 2,134, hit in May 2015. From near these levels, the S&P 500 turned down late last week. 

"I think it’s as much confusion as it’s fatigue. The market had an incredible run and could not take out the 2100 level, so there may be a lack of momentum," says JJ Kinahan, Chief Market Strategist at TD Ameritrade.  

In the short-term, "we are vulnerable to some profit digestion," says Sam Stovall, managing director at S&P Global Market Intelligence. "We went up almost 300 points in the S&P 500 showing a V shaped recovery. After that type of advance it’s normal to see some backing and filling." 

Let the finger pointing begin

There are a number of potential factors for bullish fatigue right now, Kinahan says. He highlights: 

  • An earnings season that has been very difficult to make sense of. Kinahan says, "This earnings season started with such hope, we had great reports from the financial sector and particularly as we looked at the health of the consumer." 
  • The tech industry "has been a heavy weight on the market and for evidence of that we only have to look at Apple (AAPL). This stock was hit hard after earnings as it has always had a high bar in investors' minds, and is a stock that’s relied on to set a confidence level in the market," Kinahan says. 

Will they or won't they?

Continued uncertainty around the Fed and the future of interest rates. "We’ve had a Fed that still does not look to move until the late fall at least as we look at Fed Fund probabilities," Kinahan says. 

Knocking On A Rusty Door

Seasoned traders know that when markets attack big levels like key resistance that has been in place for a long time, "round numbers" and also all-time highs, the initial attempt to crack these price points can be tough going. 

"Investors need to realize that century levels, like 2,100 on the S&P 500 or even old highs tend to act like rusty doors. They tend to require several attempts before they swing open. We could have experienced the rusty door at 2,100 and we might experience that again at the all-time high," Stovall warns. 

Bullish Catalysts?

S&P Global Market Intelligence remains upbeat on the outlook for stocks ahead. The firm maintains its 12-month target put in place at the end of 2015 with a 2,175 objective in the S&P 500, which would mark a 6% gain from the end of last year. Looking ahead, Stovall adds, "Stocks need some sort of catalyst to push the market higher." He points to two potential catalysts which could act as bullish factors: 

  • A turnaround in the U.S. manufacturing sector, which is currently in recession. 
  • A turnaround in the 2016 earnings estimate for the S&P 500. "We started the year with a 7.4% gain and now we’re looking at a minor decline," Stovall says. 

In the wake of the recent rally off the February low in the S&P 500, "prices are up and valuations are up as well. The market needs to see an improvement in fundamentals, such as earnings estimates to justify the elevated price/earnings ratio," Stovall says. Currently the price/earnings ratio stands at 17.5 for 2016 earnings, which is above the average 16.0 since 2000," says Stovall. 

Stovall warns the S&P 500 could be vulnerable to a retracement of the February-March rally which would "still be normal in an up trending market." See figure 1 below, which includes a daily S&P 500 chart with a retracement drawn off the February-April rally move. 

sp500 fibonacci retracement support

FIGURE 1: RETRACING THE RECENT RISE IN THE S&P 500.

Since bottoming out in early February, the S&P 500 rallied up into resistance at 2,100. To add this Fibonacci retracement to an S&P 500 chart in the thinkorswim® platform, type “SPX” in the symbol box and press enter. Click Drawings and then click Fibonacci Retracements. Click the low of the candle on February 11 at 1,810 and click the high of the candle on April 20 at 2,113. Chart source: thinkorswim® by TD Ameritrade. Data source: Standard & Poor’s. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.