Wednesday's sharp sell-off in equity markets saw the S&P 500 shed nearly 2 percent. Some analysts were calling the end of the bull rally, saying White House chaos has finally caught up with investors. However, as markets pared gains, both the S&P and the CBOE VIX Index failed to breach key technical levels, so the bull rally has remains in tact. "The good news is that the S&P 500 held the key 2350 level and stayed above the April and March lows, at 2328-2322, keeping the uptrend from early 2016 intact and the SPX in a bullish consolidation," Bank of America said in a recent report.
After failing to fall below 2350, the S&P has recovered and is nearing the all-time high of 2406. Should this level be breached, Bank of America sees the potential for a significant rally to possibly 2500. Aiding the recovery was the failure of the VIX to break higher. After surging over 20 percent on Wednesday, investors who have been craving volatility were bought to life. The VIX's rally, however, was short-lived. (See also: Low Volatility: The Calm Before The Storm.)
As the VIX ran into stiff resistance above 16 on Wednesday, it continued to demonstrate the inverse relationship between volatility and equities' upside. The resistance at 16 formed a double-top, and as the equity markets steadied the VIX collapsed, falling 30 percent in the four following trading sessions. This inverse correlation was most notable during the financial crisis on 2008/2009 where in a two-month span the VIX rose 370 percent as U.S. equities fell 36 percent. Other examples of the correlation were brief periods after the Brexit vote and the U.S. presidential election.
Investopedia's own volatility gauge, the Investopedia Anxiety Index (IAI) followed suit, after climbing Wednesday, it has settled back into the low anxiety zone at 97.54. For a current reading of the IAI, see our Trumponomics page.
Risk to Stocks
Despite the recovering in stocks Bank of America note one technical concern is a head and shoulders forming in banking stocks. A head and shoulders is a chart formation that has three peaks with the middle one (the head) being higher than the one preceding and proceeding it (the shoulders). Should the bottom of the two shoulders – the neckline – be breached it can signal the end of a bull run.
Bank of America believes that faltering bank stocks are the biggest technical risk to the current bull market. "A break below the neckline at 380-379 is the signal needed to confirm this bearish pattern and favor a deeper drop to 360 (measured move) and, potentially, 345-340 (2015 high/pattern count), which would retest the late-2016 upside breakout points," Bank of America said about the S&P 500 Financials Index. (See also: Why Stocks Could Fall 20%: A Technical View.)
The Bottom Line
Wednesday's sell-off now looks like a blip with both the S&P 500 and Nasdaq heading back towards all-time highs and the VIX headed back towards 10. However, should investors be on the look out for volatility, keep an eye on the key banking indexes. (See also: Top 4 Bank Stocks for 2017)