The Critical Price Level You Need To Watch
On a chart of the S&P 500 Index, the 2,800 level is becoming increasingly important. This level served as resistance for months -- and now it's support.
For those who are unfamiliar, resistance is a price level where selling pressure is expected to increase.
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As an example, we can look at how traders could have been thinking about the market in December 2018.
Back in December, as prices moved toward 2,800, nervous traders would have noticed that rallies had stopped at that level twice in the weeks prior. They may have decided that, if prices reached that level again, they would sell. Aggressive traders might have decided they would open short positions at that price since there was a likelihood of a decline from that level.
We know traders still believed 2,800 was an important level in late December because a steep selloff developed after the index touched that price. Then, prices approached 2,800 again in February, and the break above that level in the past two weeks has been bullish. Once it's broken, resistance becomes support and buyers are expected to appear if prices fall back to 2,800 in this case.
This 2,800 support level can be seen as the dashed blue line in the chart below.
Now, a significant break below that price would be a cause for concern.
In short, 2,800 is important because traders believe it is. That might sound too simple, but market prices are driven by what short-term traders and long-term investors believe. If they believe prices should be higher, they buy and push prices up. If they believe prices should decline, they sell and push prices down.
Other Reasons To Be Cautious
Market sentiment is important and, right now, sentiment could be the only reason for prices to be rising.
Fundamentals are bearish. As you can see from the chart below, analysts are cutting earnings estimates. This is a chart showing changes in estimates for the current quarter. Over the past three months, analysts lowered their expectations for companies in the S&P 500 by 7.2%. That's the biggest cut since the first quarter of 2016.
Stocks were little changed in the second quarter of 2016. The 8.2% decline in earnings estimates was followed by a 15% decline in the S&P 500. The current revisions to earnings estimates should be considered bearish based on history.
The next charts show there are reasons to be bearish on the global economy.
The chart on the left shows that world trade is down year over year. The previous two YoY declines came at the beginning of global recessions.
The chart on the right shows that manufacturers in Germany, China, and Japan are already facing recessionary conditions. It's a chart of the Purchasing Managers Indexes for Manufacturing in those countries along with the United States. PMI in the U.S. is declining but remains above 50, the critical level used to define economic growth or contraction.
In the United States, PMI is now called the ISM Manufacturing Index. This is data found in the monthly Institute of Supply Management Report on Business.
Every month, the ISM surveys factory purchasing managers. Purchasing managers are on the front line of the economy. They buy the raw materials to fill new orders. If they buy too little, factories miss delivery deadlines and lose sales. If they buy too much, they waste money with excess inventory. Profits depend on purchasing managers knowing the state of the economy.
This indicator is a leading indicator for the stock market. Breaks below 50 tend to be associated with bear markets.
Based on this and other economic data, the economy should be considered bearish.
Action To Take
So, we have bearish economic news and fundamentals... yet stocks are bullish. That's because of sentiment.
For example, consider the success of Lyft's (Nasdaq: LYFT) initial public offering (IPO), which adds to the bullish sentiment. The stock jumped more than 20% at the open on the first day of trading, an indicator there is demand for tech stocks.
In the longer run, as I explained recently, IPOs like this tend be bearish. But, for now, they are a sign that traders are bullish -- and that should be enough to drive prices up in the next few weeks.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.