Technicals Point To More Stock Market Carnage Ahead

The S&P 500 index cratered 3.6% Thursday, erasing Wednesday afternoon’s gains following this week’s Federal Reserve meeting and needing a last-minute bump to close ahead of last Friday’s lowest point since May 2021.

When Federal Reserve chair Jerome Powell took the possibility of raising interest rates by 75 basis points at once off the table, investors celebrated by pushing the S&P 500 3% higher on Wednesday. But the reality of the ongoing rate-tightening cycle to address 40-year highs in inflation sunk in a day later to take off the sugar high.

Rising interest rates have contributed to a disastrous start to the year for stocks. The S&P 500 is down 13.5% from its January 3 peak, and the tech-heavy Nasdaq Composite is down 22% after a 5% crash Thursday, fully in Bear Market territory.. For investors eagerly looking for an entry point, most strategists caution that there are still some storm clouds ahead. Powell said inflation is “much too high” at Wednesday’s meeting while announcing an interest rate hike of 50 basis points and said similar increases would be considered at its next couple of meetings.

“The one thing you learn in a bear market is that forecasting the bottom is like catching a falling pitchfork. It’s a spectacular feat if you pull it off, but it’s painful and dangerous to try,” says Jim Stack, founder and president of InvesTech Research, of Whitefish, Montana. “One of the dangers in anticipating a bottom lies an understanding that the showdown between Fed policy and inflation is just beginning.”

Sam Stovall, chief investment strategist at CFRA, called Thursday a “capitulation day” and said two technical indicators–the head and shoulders pattern and Fibonacci retracement–each suggest the S&P 500 could fall to 3,800 before it hits a bottom. That would be another 8.4% down from its current level at 4,147 and 20.8% down from its peak, broaching bear market levels. Other experts agree that investors shouldn’t necessarily expect an imminent and sustained rebound.

“We’re not expecting a runaway market to the upside where we’d have a strong bottoming process and then we rebound from there,” says Yung-Yu Ma, chief investment strategist at BMO Capital Markets. “Even when some of these things turn the corner and the market stabilizes, it’s still a market that takes a step forward and a step back and just tries to grind its way throughout the rest of the year.”

One contrarian indicator leaning bullish is the American Association of Individual Investor’s weekly Investor Sentiment Survey, which surveys its members about the direction of stocks over the next six months. The most recent survey released May 5 reported 52.9% bearish respondents versus 26.9% bullish. The historical average for bearish sentiment is 30.5%, and according to the AAII, “Unusually high bearish sentiment readings historically have also been followed by above-average and above-median six-month returns in the S&P 500.”

Stocks are likely to remain volatile as the Fed continues to combat inflation, and the S&P 500 has already lost at least 1% on 26 trading days so far this year, more than the number of such days in all of 2021. The five biggest daily declines since 2020 have all taken place in the last two months.

Amazon, Netflix and Tesla were some of the day’s notable underperformers, each losing more than 7% while Tesla founder Elon Musk’s net worth plunged more than $18 billion. Netflix is among five S&P 500 companies that has lost more than half of its value this year, along with Paypal, Etsy, Invisalign maker Align Technologies and EPAM Systems.

“We are grossly oversold, and will continue to bounce along the bottom,” Louis Navellier, chairman and founder of wealth management firm Navellier, said. “While bad stocks bounce like rocks, good stocks bounce like fresh tennis balls.”