The stock market is obsessed with a line.
The S&P 500 hasn’t closed below its 50-day moving average for two straight days since October, the longest streak in 25 years.
This story is much more than a line on the chart, though. “Buy the dip” has been the market’s mantra, and lately, it’s turned into a rallying cry. Selloffs in this market have been so elusive that we’ve gone 10 months without a 5% drop, the fifth time that’s happened in 20 years.
It’s been a fairly easy environment to ride the market’s waves, but it’s almost time for a seasonally stormy fall. And the 50-day moving average may be the first line of defense.
Buying the Dip
“Buying the dip” has been a common phrase on Wall Street. And for most of the past decade, that mindset has worked well. From March 2009 to February 2020, the S&P 500 more than quadrupled while enduring just four drops of 10% or more.
Today, buying the dip has gone mainstream. The economy and earnings are growing quickly, and the Fed is providing more market support than ever. Despite COVID’s challenges, investors have felt more hopeful than concerned as they look toward the future. Add in social media’s influence on crypto and meme stock investing, and you’ll understand why “buy the dip” has popped up on Twitter’s trending topics from time to time.
Lately, the dip-buyers have targeted one key line in the sand: the S&P 500’s 50-day moving average. While the 50-day moving average can be a key indicator for market technicians, it rarely acts like a trampoline for this long.
This year, the S&P 500 has closed under its 50-day moving average on just four days. Each time, the index rallied 1.4% or more the day after breaking the line and was back to record highs within five trading days.
Crossing the Line
The dip buyers have triumphed so far, but they may be coming up against their biggest challenge yet.
The Fed is likely to start tapering its bond purchases soon, which has caused a lot of angst on Wall Street and Main Street. And while it hasn’t caused any big swings yet, the Fed’s plans may be tough to digest against a backdrop of rising COVID cases and slowing (but solid) economic data. Plus, the market rarely stays quiet for this long.
The 50-day moving average may not be bulletproof forever. Just like a broken bed, it’s bound to buckle if you jump on it too many times.
If the index breaks its 50-day, the next step down could be the 100-day moving average at 4,262 (4.9% below current levels). Beyond that, the next floor could be the 200-day moving average at 4,021 (10% below current levels).
That seems like a long way down, but it’d be somewhat healthy after such a persistent move higher. Pullbacks happen, even in up markets.
The Stealth Corrections
Before you run for the hills, it’s important to recognize what’s been going on underneath the surface.
The market may be quiet, but its stocks are making moves. Biotech stocks have dropped as much as 15% this year. The Renaissance Index of new initial public offerings has fallen more than 20% at one point. An airline ETF, US Global Jets ETF, is 20% below its 52-week high. Tesla, the S&P 500’s best-performing stock last year, went through a 30% selloff earlier this year, and there have been magnificent swings in other names. There’s been enough of a breakdown that Wall Street analysts have sounded the alarm on market breadth.
It’s been a tough ride for some portfolios, but the churning could ultimately make the market more durable. Big selloffs tend to happen when investors are blind to risk. A pullback in a large swath of stocks could be enough to dim confidence and reset expectations without rattling the overall market. We are seeing this now. Investor sentiment has turned increasingly negative in August, but despite that, the S&P 500 has made 10 new all-time highs this month.
Sometimes, the quietest markets can mask a changing tide. Take 2017: It was one of the S&P 500’s quietest years in history, with no pullback greater than 2.8%. But the gears of the market’s engine were turning. That year, tech companies rose 37% while communications companies slid 6%, the widest divergence between best and worst-performing sectors of the 2010s.
The Bottom Line
The 50-day moving average is a bull’s best friend right now, and it’s a line we’re watching closely for clues on where the market could go next. There are several hurdles coming up that could test the market’s patience, so be prepared for swings.
At the same time, don’t over-prepare for a pullback. Quiet markets can last a while, and this market has proven to be resilient.
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Callie Cox, senior investment strategist, contributed to this article.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. 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 is a contributor at CNBC, and frequently shares her insights with various publications including the Wall Street Journal, Barron’s, MarketWatch, BusinessInsider, etc. She also serves on the board of Better Investing, a non-profit organization focused on investment education.
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