Look ahead: Stocks

After spending most of the week in consolidation mode, stocks surged higher on Thursday morning after the European Central Bank decided to cut interest rates across the board, increased quantitative easing by a bigger-than-expected 20 billion euros per month and expanded the universe of eligible securities to purchase through its quantitative easing program. But much like the Bank of Japan’s move in January, stocks quickly paired their gains before dropping sharply.

Apparently, this was in response to comments made by the ECB President Mario Draghi at the press conference when he said that he didn’t expect the central bank to cut interest rates further. This was enough to send German 10-year bond prices tumbling as yields jumped. The euro shot higher and stocks, which have been correlating positively with bonds, tanked. However, there was even more drama later on in the day as equities then surged back higher and by the very next day the losses were nearly eliminated for European stocks while the U.S. indices had actually rallied to fresh weekly highs. 

At the time of this writing, the S&P 500 was trading at just shy of 2010, a level where Thursday’s rally had come to an abrupt halt. As can be seen from the chart, below, this level corresponds with the 61.8% Fibonacci retracement against the all-time high. In addition, the area below this 2010 level and above 2000 had been strong support in the past, which on Thursdayturned into resistance (shaded in red on the chart). As we noted on Thursday in one of our reports, the technical importance of this area meant that a sell-off here was almost inevitable. We warned then that “…at this stage, traders need to be open minded to the fact this could just be a short-term pullback rather than the start of another major leg lower.”

As it turned out, it was indeed just a short-term pullback. Unless the sellers show up again here later on Friday, the S&P 500 could break further higher in early next week. In this potential scenario, a continuation in the rally towards the 78.6% Fibonacci retracement at 2066 or the bearish trend line slightly higher wouldn’t surprise us. Indeed, the momentum indicator RSI is not yet at “overbought” level of 70, so there may be some juice left in this rally.

But if the index turns lower again from around the 2010 level and forms another bearish-looking candle on its daily chart, then this would signal a clear change in the short-term trend. In this potential scenario, the S&P could break below short-term support at 1970 and potentially drop to test the old support at 1950 before deciding on its next move, which could well be to the downside given the fact that the moving averages are also pointing lower. But as things stand, the trend remains bullish.