Bank of America (BofA) issued a warning about the S&P 500 on June 26 that it was likely to undergo a significant correction (a decline in stock price) from July to September. The overall impact could affect other global stock and commodity markets as they are already in a weak position.
According to Bank of America’s Paul Ciana, Managing Director and Global Head of Technical Strategy,… Forecast for the summer months It shows a pattern of what is called an “ABC correction” in which the index moves from one low point, returns to a high point, and then falls back down in three distinct phases. If this goes as expected and is followed by a significant drop to 6,850, it would reflect a potential decline of about seven percent from what the S&P has seen recently.
Bank of America warns that technical signals are turning bearish
The bank’s warning includes three main points. The first is that momentum is going in the opposite direction to price. The S&P 500 is up nearly 17% from its lowest point in March. The 14-day RSI was at around 49 last Friday, well below the value at which the highs occurred, According to Business Insider. The second reason is that the June 1 Sequential TD 13 reading of exhaustion indicates that the current uptrend may be running out of fuel.
The third reason for the warning is that last week’s drop to 7334 on June 10 fits into the fourth wave pattern Elliot wave theoryWhich indicates that below 7,334, there will likely be a corrective phase. Although technical factors were the basis of Bank of America’s warning and not the overall outlook, Bank of America offers reasons as to why a small pullback would likely have a larger than average impact given the current composition of the S&P 500.
This year, the S&P 500’s rise has been driven primarily by a small number of large-cap technology companies, so the average price movement of the market prior to the current rise has been heavily weighted to just a few companies, shifting market focus significantly away from the S&P 500. This concentration effect will not guarantee that markets will see a correction; However, it will significantly increase the probability of a bearish technical. This could translate into sharper record declines than during periods when market leadership is more widely distributed.
“Be careful if a new marginal high occurs towards ~7,741, as this could be a ‘bullish trap’ consistent with an expanding flat,” Ciana said in a client note. According to the Investment News website.
Technology-laden driving increases the risk of correction
Bank of America’s warning comes at a sensitive time for international markets. According to the Investment News websiteThe S&P 500 is up 8.6% year to date; However, it lost 1.9% over the past month.
The tech-heavy Nasdaq fell more than the S&P, with a roughly 5% decline over the same period. The most affected sector was the semiconductor and memory chips sector. Examples: Last week, Broadcom shares fell 10%; Nvidia shares fell by 8%. Intel lost 7%, according to Business Insider.
There are also rising geopolitical tensions, raising valuation concerns regarding future corporate earnings and economic activity. Although pressure has eased somewhat due to the US-Iran conflict, it remains an ongoing concern.
In addition, pressures from rising oil prices at the beginning of this year led to enough inflation to prompt the Fed to leave interest rates unchanged during its last board meeting under new Chairman Kevin Warsh. According to Investment News.
While it is important to understand that Bank of America’s caution does not mean recession forecasts. Instead, it identifies negative technical momentum in the market and deteriorating technical conditions, rather than creating negative expectations for corporate earnings or economic activity.
This is an important point that distinguishes Bank of America’s forecasts from previous events of technical corrections, as they have occurred frequently in the past during periods when economic growth was sustained in the past.
Whether the expected pullback is re-established as a temporary consolidation or an extended downtrend will depend on whether or not upcoming earnings announcements and key economic data provide validation – or damage – to the markets’ current technical weakness.
David Lott, Chief Investment Officer at Kerux Financial Commented on investment news And what happened in the market in June was just the “tip of the iceberg.” He can expect a broader market correction (10%-20%) due to high valuations, geopolitical uncertainty, and weak trading volume in the summer. Laut suggested that since August there was only one month left. It’s a “seasonally weak month for stocks, and one that has seen corrections in recent years.”
Global markets could feel the S&P 500’s decline
US portfolio holders will not be the only ones negatively affected by the prolonged decline in US stock prices. The S&P 500 is the benchmark for trillions of passive funds globally, and a prolonged period of corrective trend-line activity will almost certainly cause increased financial pressures on global capital markets that rely heavily on US risk sentiment, including London and Tokyo.
Since S&P 500 index companies provide the backbone for many exchange-traded funds or ETFs, pension funds and institutional investment strategies that rely on tracking US stocks, a technical sell-off, due to the well-established trend of needing to implement portfolio rebalancing, may force investors to reevaluate their risk profile and allocate funds towards alternative stock types versus their existing holdings of US stocks.
Historically, these changes have tended to trickle down to non-US equities, corporate credit markets and non-investment grade commodities, particularly during the Northern Hemisphere summer months when trading volume is typically lower than in other seasons and price movements are generally much larger than usual.
Laut recommended investors maintain a negative weight in technology stocks. He stated that the group of stocks currently known as “Mag 7” has achieved a disappointing performance so far, and the market is still trying to determine which group will take the lead in the future. He strongly suggested diversification into small-cap, international and value stocks, as the overall technology group generally outperformed its benchmark, according to InvestmentNews.
Ciana’s research team does not believe the US stock market’s bull market phase will end during the third quarter or continue to deliver strong statistical performance at the end of the year, according to a report from Business Insider.
However, there is a risk of volatility resulting from a prolonged correction in the fall and the possibility of a double top as a result of price consolidation over the next few months, according to InvestmentNews.
As a result of the consensus among Bank of America analysts, investors are encouraged to consider the possibility that the three-wave decline may become less indicative of an overall bearish market call and more representative of a sharp divergence between price momentum and the amount of capital flowing into the market.
If Q2 earnings and Fed communications continue to support economic growth, and lower capital flows during Q2 are part of a normal consolidation phase before continuing to the upside, the current market consolidation may turn out to be a generally healthy and persistent component of a larger bull market.
However, if the downward price momentum trend is accompanied by weaker-than-expected earnings releases, or indications from the Fed of increasing inflationary tensions, the current pullback in US stock markets may continue to show downward momentum, as well as continue to put downward pressure on global stocks, compared to a pullback of the same magnitude that would indicate otherwise.
Watch for Fed Chair Warsh’s speech at the European Central Bank Forum in Sintra, Portugal, on Wednesday. Any comments he makes regarding the Fed’s expected interest rate policy will help determine the depth and duration of the current period of market correction.
