By David Keller, Chief Market Strategist at Stockcharts.com, and Julius de Kemepenaer, Senior Technical Analyst at Stockcharts.com
It looks like the world has now accepted that stocks are in a bear market, so that discussion is now out of the way. The next question investors need to answer is when this bear market will come to an end.
Unfortunately, there are no hard rules to call the bottom. But, using technical analysis, we can try to make an educated guess.
The Trend Is Down
Let’s start with some basic trend analysis based on previous highs and lows on the charts, as these usually provide good reference points to mark support and resistance levels. These old peaks and troughs mark periods when the balance in supply and demand turned around. The levels at which these turns occurred tend to stick in people's minds, which makes them great reference points.
The locations of these old highs and lows on a chart are the basic building blocks used by technical analysts to determine whether a market is in an uptrend or a downtrend. A series of higher highs and higher lows defines an uptrend, while a series of lower highs and lower lows defines a downtrend.
Looking at the price chart of the S&P 500 index above, we can now safely conclude that a downtrend is in play. And this downtrend will remain intact until the previous high is taken out or a new higher low is put into place. This means that, from current levels ,the S&P 500 could rise to the area just below 4180 without breaking the downtrend. Very often, old support levels like previous lows, once broken, will return as resistance.
Another technical observation, or technical rule if you wish, is that gaps “must be” – or, more accurately), “are often” – filled. In the price chart above, we can see two gaps in recent history. The last gap occurred from the close on 10 June (~3900) to the opening on 13 June (~3840), which makes that area an area of resistance. When we combine that with the fact of a cluster of lows formed in the same area during the month of May, we have to conclude that the S&P will very likely face stiff resistance between 3840 and 3900.
Value Beats Growth
Another angle to look for signals of a bottom approaching can come from the rotation between growth and value stocks. During uptrends, growth stocks usually outperform value, while the reverse is true during downtrends, when investors usually prefer value stocks.
The chart above shows the long-term development of the ratio between growth and value stocks. After a long period of rising, this ratio peaked at the end of 2020. After an initial decline into a new low in 2021, the ratio rallied again to exactly the same peak as in 2020.
From that last peak around 1.65 at the end of 2021, the ratio came down and, just a few weeks ago, completed a large double top formation by breaking the low in between the two peaks. This is known as a reversal pattern, indicating a rotation from uptrend phase to downtrend phase. Given the duration of the previous uptrend, and the magnitude of this double top formation both in terms of price and time, this suggests that the dominance of growth stocks has come to an end for now.
Within the steep decline, short-term rallies are possible and maybe even likely. However, it appears that value stocks have now taken over from growth for the time being. Given the fact that the two most important sectors in the S&P 500, Technology and Consumer Discretionary, are dominated by growth stocks, technicians are looking for this ratio to reverse back up as an early warning signal for a turnaround in the S&P 500 in the making.
This is not happening yet.
Defensive Sectors Are Leading
The third area to look for evidence of a turnaround starting to form could be in the study of sector rotation. At StockCharts.com, we use Relative Rotation Graphs to visualize this sector rotation.
The chart above shows a weekly and a daily relative rotation graph (RRG) for the so-called defensive sectors side-by-side. On the weekly version, we find details for Consumer Staples, Healthcare and Utilities at the right-hand side of the chart, which means that they are in relative uptrends versus the S&P 500, which is positioned at the center off the chart.
The decline on the vertical axis indicates a (temporary) loss of relative momentum, suggesting that these sectors are going through a pause within their longer-term relative uptrend versus the S&P 500. However, on the daily version plotted on the right in the chart above, we can see that the tails at this shorter-term timeframe are already rotating back into or towards the leading quadrant. This suggest that the temporary decline is already coming to an end and defensive sectors are starting to lead the S&P 500 again.
Strong relative strength for defensive sectors is usually associated with the general market moving lower. Hence, a third clue for a turnaround in the S&P 500 will be for the defensive sectors starting to underperform and moving into the lagging quadrant on the weekly relative rotation graph.
All in all, it is difficult, if not impossible, to figure out where this decline in the S&P 500 will end. But we can monitor the trends and some simple relationships that can provide us with some early warning signals that things are starting to change under the hood.
Disclaimer: This article is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.
The authors do not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.