U.S. Stocks: The Battle of 1840

There is a fight going on at the 1840 level on the S&P 500, and that fight will likely decide the market’s next move. It’s a key level, and a lot of smart market types watching it.

After rising as high as 1897 intraday, the S&P 500 took a straight dive down, and is now bouncing and churning around this key support level. The index tested it briefly at the open, falling to 1841.95, bounced off it again, then came back to it again. The day’s low, so far, is 1839.92. UBS's(UBSN.VX) Art Cashin puts the critical range between 1837-1840. John O’Hara at FBN thinks the market is going to churn in the 1820-1840 area this week, and test that lower boundary. “That would be a good set-up for a rally into week’s end,” he wrote.

“Remember,” Joan McCullough at East Shore Partners wrote, “the hot dogs all have pretty much the same script.” In other words, everybody’s watching the same numbers. So if there’s a break one way or another, a scramble is likely to follow.

The fall to this level represents the leading edge of a correction similar to the one earlier this year, according to Asbury Research. The firm looks at the “rate of change” in the S&P 500 – the percentage change between the most recent price and the price 21 days ago. With Monday’s slide, this rate of change “has now moved meaningfully into negative (bearish) territory,” the firm wrote in a note, “which indicates that the U.S. broad market index is beginning a pullback/correction.”

The S&P 500 and its “rate of change,” with negative rates shaded in pink. Asbury Research

That shouldn’t come as much of a shock. The markets have been rising in more or less a straight line since August of 2011 (the last time there was a significant selloff), punctuated with these minor course corrections. Indeed, you can look at the S&P 500 over the past year, and draw a line connecting all the low points. Roughly speaking, that’s the long-term trend line, a support level that the index has yet to break. That’s one reason none of the mini-corrections recently have amounted to anything. This long-term support level has held. The index would likely have to drop decisively below 1800, in fact, to break this trend.

Which is one reason why you won’t see anybody in the market getting very concerned right here. Until a long-term uptrend is broken, this is all just backing-and-filling, as they like to say. Yes, there are questions about the Fed’s stimulus efforts, we among others raised them yesterday. But for now, the Fed is still running a fairly aggressive stimulus program.

“We believe that the S&P will continue to trend higher following the trajectory of the Fed's balance sheet,” wrote the team at Macro Intelligence 2 Partners. “Since QE was launched we have only ever seen significant sell-offs when the balance sheet hasn't been growing and that really isn't a risk in the U.S. until Q3.  In that scenario, if we can drain the last drop from the Fed's punchbowl we could technically hit 1925 or even 1950 sometime in Q3 before the risks of a major broad market correction rise.”

Again, until all of this breaks that long-term trendline, it’s just course corrections.

“Allow me to put a happy spin on the meltdown in the momentum stocks,” Ed Yardeni of the eponymous Yardeni Research wrote in his daily note. “First, they are still up significantly since the start of the bull market. More importantly, their sell-off might lower the risk of a broader market melt-up that would be followed by a much broader meltdown. In other words, it still looks like a healthy internal correction that might actually be good for the longevity of the bull market.”