What Next?
Events of last week in the financial markets reminded us that markets do correct from time to time. We are in the middle of one now leaving investors wondering if they are gazing at an abyss. It is during these times that technical analysis comes to aid in estimating reasonable levels at which markets could bounce from.
To be sure, we are dealing with a market factor that affects different industries to different extents while firms assess the impacts of tariffs on their profitability. In the end, those that are able to pass on those tariffs to end consumers will come out relatively unscathed. This grand reordering of profitable industries may take some time to unfold, and investors could be left wondering what action they need to take now.
Applying technical analysis to the monthly chart of the S&P500, we can make a few interesting observations.
1. The financial markets are still in an uptrend! The upward vector is from the lower left corner of the chart below to the upper right. No cause for panic yet.
2. The rally from late 2022 until March 2025 has reached its end and we are in a correction which is progressing as we speak. The following downside targets can be estimated for now.
(a) A Fibonacci retracement of the rally from late 2022 puts the 38% retracement at between 450-475
(b) A trendline from the low of 2022 intersects this line again at between 450-475
(c) The 50 period simple moving average of prices also converges to this range of 450-475
When points such as a, b and c converge it is also referred to as a “confluence of indicators” meaning that it becomes significant as market participants take note. Short covering as well as cautious buying may reenter the market at these levels. This is not to say that this is the final low for this period as this could come much later. Short term participants may take a long view around these levels for a relief rally which could run into resistance down the road. This is where those participants who are still long their holdings at much higher levels would look for a second chance to do so.
For now, certain things are clear;
- A correction has commenced which could well last a few months as implied by the term structure of VIX futures which is firmly in backwardation.
- A partial market recovery is likely by year end as the market reassesses the impact of tariffs and as implied by the options market
- Implied volatilities are running at the 100th percentile making put underwriting an attractive strategy during these uncertain times. Particularly, if investors do not mind owning stocks at the chosen lower strike levels.
Please feel free to reach out if you have any questions or if you wish discuss strategies for volatility risk premium capture.
Sowmi Krishnamurthy CMT
SK Market Insights Ltd
