The immediate risk to bulls is the bearish “island reversal” still in play
“...the SPX’s Jan. 24 close at 6,101 that preceded last Monday’s gap lower has not been filled on a closing basis…Therefore, the potential reversal pattern that surfaced last Monday has yet to be invalidated, which presents a short-term risk for bulls. A close above 6,101 would invalidate the bearish signal and tilt the odds more in the bulls’ favor from this perspective.”
-Monday Morning Outlook, February 3, 2025
Amid tariff uncertainty and rising interest rates since early December (as measured by the 10-year Treasury note yield), the S&P 500 Index (SPX – 6,025.99) has so far dodged a couple of potential short-term and intermediate-term bearish technical signals. The first was in January, when the neckline of a potential bearish “head and shoulder” pattern broke on an intraday basis, but not a closing basis.
The second was a bearish “island reversal” that developed on the Jan. 27 gap lower and remained unfilled on a closing basis going into last week’s trading. The rally that failed to fill that gap preceded a continuation gap lower last Monday that was quickly filled on Wednesday’s close.
But given that there still has not been a close above the Jan. 24 close (that preceded the Jan. 27 gap lower) at 6,101, the risk to bulls is the bearish “island reversal” still in play, albeit there have not been any immediate negative consequences of note with the SPX above the Jan. 27 low.
Bulls, on the other hand, are hopeful that the bearish pattern simply signaled choppy short-term price action, as the SPX makes its way to 6,215, which is the target for the bullish inverse “head and shoulder” neckline breakout that occurred in September.
Since the election in early November and a rate cut that same week, choppy is the best way to describe the SPX’s price action. As such, this week’s SPX chart takes you back to early October to give you a better perspective on the environment, which has presented challenges for bulls and bears.
For example, the 20-day average true range (which is a measure of the distance of the high and low and considers the previous day’s close if a gap occurs) for the SPX range is 71 points amid the non-directional movement, whereas the 20-day average true range hit a low of only 46 points in the rally from August into October. In other words, whereas we are seeing more intraday volatility in the SPX, this action is in the context of little directional movement.
If we shorten the perspective to mid-January, the SPX is just above multiple potential support levels, but also just below previous highs attained last month between 6,119 (the all-time closing high) and 6,128 (the all-time intraday high).
Potential support levels can be seen in the above graph in patriotic colors red, white, and blue. The first key level (in red) is 6,013, which marked highs in November and again in early January. The white is the pre-Inauguration Day close of 5,995 in mid-January. As the market reacts to both negative and positive headlines on tariffs, it is of note that the SPX has closed either above or on this level each trading day since the inauguration of President Donald Trump.
Finally, the blue line segment at 5,975 in the chart above represents the site of the trendline breakout level that connected lower highs from mid-December through mid-January. There has not been a close below this level, albeit two intraday moves below, since the trendline breakout.
If these support levels are breached, the Election Day close at 5,783 could be retested, as it was last month. Given President Trump likes to cite the stock market as a sign of economic health, the pre-inauguration and pre-election closes should be on your radar. Just above the pre-election close is 5,881, or last year’s close, which can also be of importance.
“Mom-and-pop investor sentiment has reached the highest level on record, surpassing what was seen during the meme-stock mania in 2021, according to Emma Wu, JPMorgan’s global quantitative and derivatives strategist. Individual investor exposure to stocks is near the highest level its been since 1997, an analysis by Barclays’ global head of equities tactical strategies Alexander Altmann shows. And as long as the US economy remains resilient, those investors probably will stay in the game.”
-Bloomberg, February 6, 2025
An argument for the 5,783-5,881 area being tested is that optimistic retail investors must get flushed out before the market gathers strength again, if that is in the cards. The excerpt above from Bloomberg suggests a bullish retail crowd, and our data that measures sentiment among equity option buyers on SPX component stocks echoes the analysts from JPMorgan and Barclays.
One scenario worth considering is that the 10-year yield is sitting on potential support from its 80-day moving average and the November closing high ahead of inflation data this week. If the retreat from higher yields since mid-January is over, a potential headwind for equity bulls is higher 10-year yields stemming from higher-than-expected inflation data on Wednesday and Thursday.
Stay tuned, as inflation data on Wednesday and Thursday could dictate the course of the equity market in the weeks ahead as investors continue to weigh tariff headlines.
Todd Salamone is Schaeffer's Senior V.P. of Research
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