S&P 500 outlook: Stocks could resume drop after Thursday’s reversal

US index futures managed to bounce off their lows in the first half of Friday’s session, with European stocks also attempting a recovery. It remains to be seen whether the recovery will hold in light of the big reversal signs we saw on Thursday. The short-term S&P 500 outlook could turn bearish if we see some downside follow-through below Thursday’s range when it formed a rather large outside candle after the fresh breakout to a new all-time high was met with strong selling, despite Nvidia’s strong showing. Ahead of the long weekend, I would be very surprised if we see fresh all-time highs today.

Before discussing the macro factors impacting market sentiment, let’s quickly look at the chart of the S&P 500 which is displaying a very interesting price candle:

S&P 500 outlook: Key levels and factors to watch

Source: TradingView.com

The big bearish engulfing reversal pattern on the S&P 500 that we saw on Thursday from an all-time high, means we may have seen at least a temporary top in the markets. At the time of writing, index features were higher, making back a bit of the losses suffered on Thursday. Specifically, the S&P 500 was testing the low from Thursday’s range at 5285, where I would expect the potential downside to resume from. It is crucial that the bears now defend this broken support level to maintain control of short-term price action. The bulls will need to proceed with extreme care in light of Thursday’s reversal-looking price action, until we (1) either see evidence that Thursday’s reversal candle was in fact just another bear trap or (2) get a decent pullback to remove some froth from the market.

So, on the upside, 5285 is the most important resistance to watch, followed by 5326, which was resistance until the brief breakout we saw on Thursday. The all-time high came in just below the 5350 level.

In terms of support, 5250 looks like an interesting level to watch for a possible bounce from. However, this is not a key level. Much lower, at 5122, we have the base of the breakout that took place early this month, followed by the psychologically-important 5,000 level.

While Thursday could turn out to be major high, it is worth pointing out that we have seen similar price patterns in the past and in all cases, we only saw minimal further downside follow-through. The market’s trend has been very strong. The trend needs to weaken first and foremost before the bears feel they have full control again.

Why did the markets drop on Thursday?

Well, in short it was triggered by expectations the Fed’s first interest rate cut could delayed by several further months, after a much stronger-than-expected US business activity ended a run of soft data releases. Interestingly, the major indices fell even though Nvidia’s earnings results came in better, sending the stock up more than 10% higher at one point. But the rest of the tech sector fell, as too did interest-rate sensitive homebuilders. Traders were happy to book profit on tech names after what has been another strong month, ahead of the Memorial Day weekend on Monday, with many traders likely to have taken Friday off too.

S&P 500 outlook: Key macro highlights to look forward to for rest of May

We don’t have much in the way of key data to look forward to today, except US durable goods and revised UoM consumer sentiment data, plus a couple of Fed speakers. Thursday’s other data releases apart from the services PMIs were mixed, keeping investors guessing in so far as the Fed’s rate cuts are concerned.

Looking ahead to next week, the crucial data will be released on the last day of the month when the Fed’s favourite gauge of inflation is published. The core PCE figures will come a week before the May jobs report. Until then, the dollar may remain in a holding pattern following its gains through much of this week and the drop the week before.

Stagflation concerns are rising in the US, with price pressures remaining higher and incoming data mostly surprising negatively of late, which does not bode well for the economy. The PCE data could impact the timing of the first rate cut significantly and potentially the S&P 500 outlook too.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R