Stocks tend to follow the fundamentals over the long-term. But lately, it’s been all about the technicals.
When we talk about “technicals,” we’re referring to technical analysis – the study of trading patterns, trends, and key levels in securities that can be helpful in determining stocks’ next moves.
For the past month, the S&P 500 has been stuck in a trading range bound by two important levels that technical experts have been watching closely. This week, the index tried to break out of the range and find some direction after weeks of waffling around.
Many investors use technical analysis as a supplement to fundamental analysis – the study of corporate earnings outlooks, market valuations, and economic data – to form a holistic view on a security’s direction. However, there isn’t much fundamental evidence available at the moment. Economic data has been slow to react in quickly changing conditions, and a swath of companies have withdrawn earnings guidance, leaving fewer clues on the path of profits.
Technical analysis encompasses a wide range of levels, patterns and formations in a security’s price movement. The studies can get complex – ever heard of the “cup and handle” formation? Ironically, though, one of the simplest technical analysis metrics – the moving average – is also one of the most revered. Moving averages are simple averages of an index’s historical closing values and can be used to show market trends by smoothing out daily price fluctuations. Technicians refer to moving averages as “support” (a potential floor) and “resistance” (a potential ceiling), due to the market’s propensity to bounce off these levels like a ping-pong ball.
Lately, stocks have been unusually attached to moving averages. The S&P 500 closed below its 200-day moving average and above its 50-day moving average for 22 straight trading days, the longest streak since the 2016 presidential election. Technicians call this range-bound period “consolidation,” or when the overall market gets stuck in a rut and moves sideways. The benchmark has also closely tracked its 20-day moving average for the past month.
On Wednesday, the S&P 500 finally broke free from its trading range. That day, the index jumped 1.5%, closing about 1% above its 200-day moving average. That same day, the S&P 500 also eclipsed 3,000 – a round number it has struggled with in the past. Typically, big, round numbers don’t mean much for market valuation or fundamentals, but they can sometimes be a psychological block for investors. For example, the S&P 500 took four shots at 3,000 in 2019 over a 3-month period before the market pushed meaningfully higher. The “round number” phenomenon isn’t a technical rule, by the way, but it is something to be aware of.
Over time, the cross above 3,000 could play into the bulls’ (market optimists) hands. Stocks may not have moved much in the past few weeks, and history shows a prolonged period of market consolidation can act as a coiled-up spring: Keep it compressed for too long, and it could explode (in either direction).
Since 1990, there have been 10 instances when the S&P 500 closed between its 50-day moving average and 200-day moving averages for 22 days or more. On average, the index gained 9.4% over the next three months if it broke through the ceiling of the range. On the other hand, the index’s average three-month forward return was -3% if it broke through the floor of the range. While the results are mixed, past ranges show there’s a good setup for the market to push higher in the coming months.
Poised for takeoff?
The S&P 500 has pushed above its range, and there are few technical barriers in sight from here until record highs. If you believe the old adage “the trend is your friend,” then stocks could be poised for takeoff.
But there’s still a lot of uncertainty present, even though investors have high hopes for the future. As the calendar moves into summer, we’ll be keeping our eyes on changes in fiscal and monetary policy, the development and distribution plans for vaccines, the speed of the economic recovery, and U.S.-China tensions.
The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She frequently shares her knowledge as a guest on national news outlets such as CNBC, CNN, Fox Business News, and Bloomberg News. She also serves on the board of Better Investing, a non-profit organization focused on investment education.