S&P 500 outlook starting to turn a little bearish

The major US indices were bouncing off their earlier lows, but still holding in the negative territory, while the Russell was higher on on the day. The mixed performance for US indices comes after the European markets staged a recovery when the session got underway there, while shares in China fell overnight. After a weaker close on Wednesday following a series of disappointing US Treasury auctions and a sell-off in long-dated bonds, it remains to be seen whether the major US indices likes the S&P and Nasdaq 100 will be able to regain their poise as the session wears on. The Dow had extended a two-week drop, now 5% off from its record high to reach lowest point since early May. Concerns over prolonged high interest rates have started to undermine stocks a little, with risk appetite waning amid a lack of major fresh bullish catalysts ahead of Friday’s publication of core PCE price index. A potential close below 5250 today could turn the S&P 500 outlook bearish in the short-term perspective.

What is driving market sentiment right now?

The market is increasingly concerned about the possibility of prolonged elevated interest rates, not just in the US. Although there is no outright panic yet, it is becoming harder to justify continued share purchases in the absence of new catalysts.

The stock market rally has been sustained for months by strong demand for technology shares, propping up indices like the Nasdaq 100 and S&P 500 despite weaknesses in other sectors. However, technology shares now seem overextended, indicating that a correction may be imminent. After months of significant gains and no new bullish catalysts, a correction shouldn't be surprising.

Much will depend on the upcoming PCE inflation data and the direction of bond yields.

The recent sell-off in bonds has been partly driven by an unexpected rise in US consumer confidence in May and weak US Treasury auctions. The Fed’s ongoing hawkish stance has also bolstered the dollar and yields, with several officials downplaying the likelihood of an early rate cut in recent speeches.

S&P 500 outlook: technical analysis and trade ideas

Source: TradingView.com

The short-term technical outlook has turned somewhat bearish since the formation of that bearish engulfing pattern on the S&P 500 from last Thursday and the small doji candle on the weekly time frame at record highs (see weekly chart). The fact that we have now broken below it points to a possible temporary market top. But what the bears need to see now is some real downside follow-through, which has so far been lacking. Could this change this week?

Bears need more conviction to turn the S&P 500 outlook bearish. A break below the 5250 support level on a closing basis, a level which aligns with the 21-day exponential moving average, could trigger follow-up technical selling in the days ahead. However, if the index recovers, like the European indices did earlier today, to close back in the positive, then this should scare the bears away.

Short-term resistance is now seen around 5281, which was the low from Tuesday, before it gave way decisively following Wednesday’s breakdown. Subsequent resistance is seen around 5325ish, ahead of the all-time high of just under 5350.

Bulls should be extra cautious due to the recent bearish price action. That is until it becomes clear that the recent bearish price action was all just a bear trap, or after we have seen a decent correction to reduce market froth.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R