Has the Market Bottomed Out?

The Dow Jones Industrial Average rose 2,113 points on Monday, the biggest one-day gain since March 1933, prompting a boatload of armchair analysts to declare that the market had "bottomed out." Gains in the past two sessions have added to this impression, underpinned by V-shaped rallies that saved the day throughout the 10-year bull market. However, bottom callers forget that the market hates uncertainty, and we've entered the most uncertain period in U.S. history since World War II.

Stocks and indices have bounced at deep support levels after hitting extreme oversold technical readings. An "oversold bounce" can be quite vigorous, fueled by extensive short covering by weak-handed players who chased the downside. These vertical impulses fail the vast majority of time, usually at easily observed resistance levels. In turn, that tells informed market players to watch price action closely around the 2,700 level on the S&P 500, or $270 on the SPDR S&P 500 ETF Trust (SPY).

Chart showing the share price performance of the SPDR S&P 500 ETF Trust (SPY) with Fibonacci grid

Downside since February has unfolded through a potential Elliott five-wave decline that completed a third wave on March 23, ahead of the current fourth wave bounce. The sell-off carved a continuation gap right at the dead center, which typically projects the halfway point for the first major downswing of a developing bear market. Pullbacks to continuation gaps during fourth fourth wave countertrends set off major sell signals because the barrier is tough to breach on a first try.

A Fibonacci grid stretched across the one-hour chart, with the 50% level at the continuation gap, places the final terminus for this Elliott wave pattern near $190. However, this doesn't predict a final "bottom" because we don't know if there will be larger-scale down waves in the future. But for now, it offers a useful projection for immediate downside and how that might affect your portfolio.

Chart showing the share price performance of the SPDR S&P 500 ETF Trust (SPY) with stochastic oscillator

The sell-off broke an 11-year trendline and the 50-month exponential moving average (EMA) when it cut through $260, marking the first time the S&P 500 is trading under the moving average since 2011. The current bounce is testing new resistance from the downside, but since this is a monthly breakdown, there could be multiple whipsaws before resistance is confirmed or support is remounted. This uncertainty highlights $270 once again as a line in the sand between an oversold bounce and an impulsive rally that signals a longer-term low.

The monthly stochastic oscillator entered a long-term sell cycle in February 2020, predicting at least six to nine months of relative weakness. The indicator is now expanding through the panel's midpoint, telling us that sellers remain in control of the tape despite this week's bounce. The signal line is also trying to play catch-up right now, adding downside pressure that is likely to re-exert its strong influence in coming sessions.

Chart showing the share price performance of the SPDR S&P 500 ETF Trust (SPY) with OBV indicator

Finally, consider SPY cash flows in the past few months. The on-balance volume (OBV) accumulation-distribution indicator topped out in March 2018, at the same time that trade war anxiety hit the ticker tape. OBV returned to resistance in February 2020 and broke out, but it failed the breakout a few sessions later when the virus outbreak expanded in the United States. Distribution since that time has been intense, with panicked shareholders escaping through the fire exits.

This week's bounce started just above the December 2018 low, which signals a bullish divergence because price action has broken that level, but that's where the good news ends. It took nine months of selling pressure to swing from high to low in 2018, but we've accomplished the same task in just five weeks this time around. That signals a far more destructive event than the 2018 occurrence, with the likelihood that OBV will soon hit new lows.

The Bottom Line

Bottom callers are coming out of their caves, but a close look at S&P 500 technicals predicts lower lows in coming weeks.

Disclosure: The author held no positions in the aforementioned securities or their derivatives at the time of publication.

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