Over the last few weeks, volatility has reemerged in the broader markets as the VIX, the fear gauge for stocks, is trading back up near its highs of the year. And with the S&P 500 sitting near 2440, the index is about to test crucial support. How it reacts to this support zone will most likely dictate trading for quite some time.

To recap the last few weeks, the declines we have seen off the all-time high of 2490 in the S&P 500 first came off news of escalated tensions between the United States and North Korea. As those fears subsided, new ones arose after the events in Charlottesville and President Trump's reaction to them. The biggest worry for the markets is whether the President's economic agenda is now in trouble. Concerns over whether his tax-reform and infrastructure plans can get support in Congress have elevated, and what happens over the next couple of weeks will determine their future.

Looking at technical indicators for the S&P 500, the 2440 level first became important in July after the index gapped above this level and broke out of a consolidation pattern from late June. Then it retested this gap level last week and found support. If the S&P breaks that 2440 level, the next support level would be 2410, which is the June and July low. If the S&P falls to the 2410 level, that would be a three percent correction off its highs.

Chart source: TradingView

This sell-off over the last couple of weeks should be taken seriously for two reasons. First, the VIX has confirmed the sell-off with its own move up, which means there is fear in the market and an increasing sense of worry among participants. The VIX represents the cost of at-the-money put options for the S&P. As the VIX increases in price, the cost of buying puts in the S&P increases (as there is greater demand for them and expected S&P volatility increases). Second, the Russell 2000, which measures the performance of small-cap stocks, is down much more significantly, falling five percent in three weeks. In a bullish market, one would like to see small caps outperform the broader market, so to see such a significant underperformance is noteworthy.

The Bottom Line

With the recent sell-off in the S&P 500, it is vulnerable to a continued move to the downside should it break key support at 2440. With all the negative political headlines, worry over the future of President Trump’s economic agenda is sending broader markets lower. Watching how the VIX performs will also clue market participants to how significant this recent pullback is.

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