Analysts say that U.S. stocks may see some relief this week, but caution that the current late-summer selloff is far from over.
Technical analysts believe that any bounce in the market will be temporary, as the S&P 500 continues its downward slide towards the next major support level at 4,200.
Several indicators suggest that the S&P 500 and Nasdaq-100 have reached “oversold” territory. For instance, as of Friday’s close, only 15% of S&P 500 stocks were trading above their 20-day moving average. This data was highlighted by BTIG’s Jonathan Krinsky and Jeffrey deGraaf of Renaissance Macro.
Krinsky and deGraaf also pointed out the recent spike in the 10-day U.S. equity put-call ratio, which is at its highest level of 2023. This indicates that traders have been stocking up on put options, which typically benefit from stock price declines.
Despite the signs of oversold conditions, Krinsky believes that the selloff is only halfway complete. He predicts that any bounce in the market will fade around the 4,450 level, while technical strategists are keeping a close eye on the long-term support level at 4,200, which held as a ceiling for stocks for over six months.
Katie Stockton, founder and managing partner of Fairlead Strategies, shares a similar assessment. She expects the S&P 500 to find support just below 4,200, which would erase most of this year’s gains. According to FactSet data, the S&P 500 was up almost 20% for the year at its recent highs.
One notable difference in this selloff compared to previous ones is the subdued spread between Treasury yields and yields on corporate bonds. This stands out from the October lows and the market turbulence following the collapse of Silicon Valley Bank in March.
In conclusion, while some near-term relief may be expected, analysts believe that the selloff still has a long way to go. The focus remains on key support levels, such as 4,200 for the S&P 500, as the market continues to navigate through uncertain times.
Equity Valuations and Corporate Bond Spreads: A Close Relationship
Nick Colas, an expert at DataTrek, highlights in a recent research note the surprisingly low spreads for corporate bonds. Even with investment-grade corporates at 1.26 percentage points over Treasurys and high-yield bonds at 3.95 points, these spreads remain remarkably low.
This trend suggests that investors are dialing back equity valuations, which many believe have reached stretched levels, based on expectations of corporate earnings. In fact, the S&P 500’s forward 12-month price-to-earnings ratio was 19.4 in late July, higher than both the five-year average of 18.6 and the 10-year average of 17.4 (according to FactSet data). However, over the past three weeks, the index has declined and now stands at 18.6, in line with its five-year average.
According to Colas, this month’s disparity can be attributed to equity valuations, a factor unique to stocks. Therefore, investors are closely monitoring corporate bond spreads, especially as long-dated Treasury yields continue to rise. If these spreads start increasing, it could be a sign that bond investors are becoming concerned about rising borrowing costs, which may impact corporate cash flows and profits.
On Monday, U.S. stocks mostly closed higher after the Nasdaq Composite finally broke its four-day losing streak with a gain of 1.6% (206.81 points) to 13,497.59. The S&P 500 also saw a rise of 0.7% (30.06 points) to 4,399.77. Conversely, the Dow Jones Industrial Average fell slightly by 0.1% (36.97 points) to 34,463.69. It is worth noting that both the S&P 500 and Nasdaq have experienced three consecutive weeks of declines.
This week is expected to present various risks for stocks, including a speech from Federal Reserve Chairman Jerome Powell, as well as an earnings report from Nvidia Corp.