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The S&P 500/ SPDR S&P 500 ETF (SPY) has seen some wild swings lately, often fluctuating by multiple percentage points throughout one trading day. The significant uptick in volatility has been quite noticeable in recent weeks as the VIX has nearly doubled in that time. The recent nervousness in stocks has translated into another 10% correction from peak to trough over the last month.
Noticeably, the latest price action has been around an important technical point which coincides with the first leg’s bottom in this correction. This also puts SPY right above critical technical support. The troubling factor is that if the current support level folds the S&P 500/SPY, and stocks in general could go a lot lower over the next weeks and months.
Background Information About SPY
SPY is the first major and most popular ETF in the world. It’s designed to mimic the exact movement of the S&P 500. The SPY index fund has roughly $275 billion in net assets, and each share in the fund represents a fraction of the holdings. In addition, SPY provides investors with exposure to the S&P 500 index, which is widely regarded as the most significant stock market average for U.S. equities. Since SPY tracks the exact movements of the S&P 500, I use SPY and the S&P 500 interchangeably throughout the article.
Stocks Face Many Headwinds
From historically high valuations, to fears of a trade war, to endless political scandal, to Fed tightening, and to numerous other fundamental issues this bull market has so much to worry about. But that’s what it still is, a bull market essentially. Therefore, this is still just a correction, and a healthy one at that. Will it remain “just a correction”?
The point of SPY’s breakdown or break higher is approaching rapidly, possibly this week. This upcoming move should give market participants a clearer idea about where stocks are ultimately headed in the short to intermediate term.
There are Positives Developments as Well
Favorable elements for stocks going forward:
- Robust but tame inflation
- A relatively soft dollar
- Fairly low interest rates
- Tax cuts
- Infrastructure spending
- Growing corporate profits
- Increased GDP
- Improved all around economic activity
- Positive sentiment
Volatility is High but Not Like Last Time
One noticeable difference between the first and second leg of the current correction is the evident drop in volatility and volume during the latest decline. As wide as the latest intraday fluctuations may seem they are nowhere as extensive as they were two months ago. The VIX is far lower now, about a 22 vs as high as 50 back in February.
Essentially the VIX was twice as high back then, suggesting market participants are far less fearful, scared, and nervous right now. Also, the volume is notably lower now than it was during the former decline. In total, market volatility will begin to subside from here if a successful retest of the original correction lows has been attained during the recent retest.
The current correction has been going on for about two and a half months now. This is roughly on par, time and depth (10-12%) wise with many prior corrections. The chart shows a textbook double bottom/correction retest low. We’ll find out soon whether this level will ultimately hold. SPY’s price has been scaling the 200-day moving average in an apparent attempt to consolidate here, a constructive technical indicator. Roughly the 257 level in SPY and 2,580 on the S&P 500 represent critical support. Any decisive break lower beyond this point will be very negative technically and could lead to much lower prices in the future. However, if we stay above these levels stocks are likely to regain their uptrends going forward.
SPY, and stocks in general are at a critical point. There are certain fundamental elements that are currently weighing on stock prices. Fed tightening, fears of a trade war, and other headwinds are fanning the flames of volatility. But there are plenty of positive developments as well. Tax cuts, GDP growth, record profits, and other favorable factors should at least counter the negative factors if not completely make up for them. The “big deal” is the current technical setup that will either serve as a breakdown point, or a bottom of sorts going forward.
Also, the VIX signal, with volatility so much lower than where it was about two months ago during the height of the correction suggests that investors are far more comfortable with their positions. There is not that much panic in the air this time, and it may indicate that the selling will dissipate soon. With a likely further decrease in volatility going forward stocks should regain their upward momentum in the coming weeks.
I believe now is probably a good time to reload on some of the top stocks. My sectors of preference remain big tech/FANGs, financials, mining/basic materials, defense, and energy. However, my main concern remains the fact that SPY is so close to the breakdown level, and if support falters meaningfully in the next few days stocks could fall a lot lower.
Disclaimer: This article expresses solely my opinions, is produced for informational purposes only, and is not a recommendation to buy or sell any securities. Investing comes with risk to loss of principal. Please always conduct your own research and consider your investment decisions very carefully.
Disclosure: I am/we are long Various stocks in the S&P 500.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.