By William Watts
Stock-market bulls arguing that the U.S. bear-market bottom is in got a boost Friday when the S&P 500 closed above a key chart level, though technical analysts warned that some volatile trading may be in store after an impressive summer bounce.
The S&P 500 /zigman2/quotes/210599714/realtime SPX +3.06% on Friday rose 1.7% to close at 4,280.15. The finish above 4,231 would mean the large-cap benchmark has recovered — or retraced — more than 50% of its fall from a Jan. 3 record finish at 4796.56.
“Since 1950 there has never been a bear market rally that exceeded the 50% retracement and then gone on to make new cycle lows,” said Jonathan Krinsky, chief market technician at BTIG, in a note earlier this month.
Stocks rose across the board Friday, with the S&P 500 booking a fourth straight weekly gain. The Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +2.80% advanced more than 420 points, or 1.3%, on Friday and the Nasdaq Composite /zigman2/quotes/210598365/realtime COMP +3.34% rose 2.1%. The S&P 500 attempted to complete the retracement in Thursday’s session, when it traded as high as 4,257.91, but gave up gains to end at 4,207.27.
Krinsky, in a Thursday update, had noted that an intraday breach of the level doesn’t cut it, but had cautioned that a close above 4,231 would still leave him cautious about the near-term outlook, warning that the “tactical risk/reward looks poor to us here.”
Stock-index futures were modestly lower ahead of Monday’s opening bell.
A shaky performance in the 30 days after scoring a 50% bear-market retracement wouldn’t be out of keeping with history, but longer term performance is more encouraging, said Sam Stovall, chief investment strategist at CFRA, in a Monday note.
“On average, the ‘500’ had a tendency to digest some of the gains after reaching the 50% threshold, or recording a new bull market, as the average frequency of advance (FoA) was only slightly better than that of a coin toss at 54%” over the next month, he wrote (see chart above).
“Two and three months later, however, the S&P 500 posted FoAs of 77% and 69%,respectively,” he said.
The stock market’s bounce off the June lows has encouraged bulls looking for signs the bear-market lows have been established. History, however, shows that bear-market rallies can be quite strong, leaving investors wary the summer bounce could prove to be yet another head fake, even with the S&P 500 clearing the 50% retracement hurdle.
What’s so special about a 50% retracement? Many technical analysts pay attention to what’s known as the Fibonacci ratio, attributed to a 13th century Italian mathematician known as Leonardo “Fibonacci” of Pisa. It’s based on a sequence of whole numbers in which the sum of two adjacent numbers equals the next highest number (0,1,1,2,3,5,8,13, 21 …).
If a number in the sequence is divided by the next number, for example 8 divided by 13, the result is near 0.618, a ratio that’s been dubbed the Golden Mean due to its prevalence in nature in everything from seashells to ocean waves to proportions of the human body. Back on Wall Street, technical analysts see key retracement targets for a rally from a significant low to a significant peak at 38.2%, 50% and 61.8%, while retracements of 23.6% and 76.4% are seen as secondary targets.
The push above the 50% retracement level during Thursday’s recession may have contributed to a round of selling itself, said Jeff deGraaf, founder of Renaissance Macro Research, in a Friday note.
He observed that the retracement corresponded to a 65-day high for the S&P 500, offering another indication of an improving trend in a bear market as it represents the highest level of the last rolling quarter. A 65-day high is often seen as a default signal for commodity trading advisers, not just in the S&P 500 but in commodity, bond and forex markets as well.
“That level coincidentally corresponded with the 50% retracement level of the bear market,” he wrote. “In essence, it forced the hand of one group to cover shorts (CTAs) while simultaneously giving another group (Fibonacci followers) an excuse to sell” on Thursday.
Krinsky, meanwhile, cautioned that previous 50% retracements in 1974, 2004 and 2009 all saw decent shakeouts shortly after clearing that threshold.
“Further, as the market has cheered ‘peak inflation’, we are now seeing a quiet resurgence in many commodities, and bonds continue to weaken,” he wrote Thursday.
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