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4 Red Flags The S&P May Pull Back Sharply

The most widely-followed barometer of the U.S. stock market, the S&P 500 Index (SPX), has staged a dramatic recovery from its December low, but a key technical indicator suggests that the S&P's rally -- and the broader market rebound -- may lose steam. "This area right here makes me very nervous because there's actually four significant technical levels here," says Todd Gordon, founder of TradingAnalysis.com. "The 200-day moving average right here--we have tried it once, twice, three, coming back on a fourth time," he told CNBC

Adam Kobeissi, founder and editor-in-chief of The Kobeissi Letter, has a similar view. “Looking forward, we believe that upside is limited and buying equities now presents a highly unfavorable risk-to-reward ratio as expected return has dwindled with recent bullishness,” he said, as quoted by MarketWatch. “We maintain our target at 2,550 on the S&P 500 and believe that short positions in equities are set for a great few weeks,” Kobeissi added.

The S&P 500 May Pull Back

(One Technical Analyst's Target)

  • S&P 500 opening value on Feb. 19: 2,769
  • S&P 500 target: 2,550
  • Forecasted decline: -7.9%

Source: The Kobeissi Letter, as reported by MarketWatch

Significance For Investors

Gordon at TradingAnalysis.com has a specific reason for being concerned by the fact that the S&P 500 has pulled back three times in recent weeks after approaching, but not exceeding, its 200-day moving average. That's because a fourth failure would represent a so-called quadruple top, and he is among those technical analysts who take this as a very bearish signal.

As of the open on Feb.19, the S&P 500 had advanced by 18.0% from its low in December. Despite concerns about a slowing global economy, Kobeissi believes that a turn towards dovishness by the Federal Reserve and optimism about a trade deal between the U.S. and China have been key drivers of the rally. He warns that stock prices now reflect bullish scenarios on interest rates and trade. Thus, he says the market has limited upside and significant downside should reality fail to reach expectations.

Regarding the U.S.-China trade talks, a detailed report from Citigroup is less than optimistic about their likely outcome, as summarized by CNBC. Meanwhile, veteran market analyst Mark Hulbert sees dangers in the fact that "the mood has shifted from the extreme pessimism that prevailed in late December to nearly as extreme optimism today," per a column in MW.

"This is going to be a deadly battleground," Gordon stated. "I want to short it but I want to be very diligent and get a good price, stop out above 2,900..I think we sell off but it's going to be very volatile for a period," he added. A value of 2,900 on the S&P 500 would represent a 4.7% gain from the Feb. 19 open.

Other investors also see limited gains ahead. "We're really not looking for much more than a 5 percent increase in the near term," is the opinion of Erin Gibbs, a portfolio manager at S&P Global, in remarks on CNBC. She expects the S&P 500 to post 4.6% earnings growth in 2019. Meanwhile, Morgan Stanley, which has led Wall Street in anticipating a sharp slowdown in corporate earnings growth this year, sees just 1% profit growth in their base case, and assigns increased odds to a bear case in which profits drop by 3.5%.

Looking Ahead

The inability of the S&P 500 to break through its 200-day moving average is just one of several red flags indicating that caution may be warranted. The deteriorating profit picture for the S&P 500 also offers a fundamental reason for concern about stocks in 2019, and geopolitical uncertainties such as the U.S.-China trade impasse offer yet more. While bearish panic may not be warranted at this time, it probably is unrealistic to expect significant upside.