On Wednesday, the day before the low, we published a detailed note summarizing the low-risk, high-reward long set up, as well as what to expect next (please read it here).
The two week down-move in SPX retraced all the gains from May 2 onwards. The 2000-07 resistance zone that we had expected to hold in April was back-tested as well (chart). In essence, risk was removed as was any opportunity-loss in May.
What to expect next:
Upside: it would be 'normal' for SPX to at least attempt a retest of the recent highs in the coming weeks. That is a pattern that has played out in almost every strong uptrend over the past several years (yellow shading in chart).
Downside: SPX 1600 obviously becomes key to hold. A quick return to that level, and a 38% retrace of the rally from November would be likely, bringing SPX back to 1550, also the key support during March and April lows (chart). Incidentally, the powerful 2006-07 advance (that this rally has been compared to) retraced by 38%. And, 1550 also represents an 8% drawdown off the YTD highs; since 1980, SPX has declined by at least 8% intra-year in 80% of instances.
On Wednesday, we mentioned that the brief retrace so far had not 'reset' the market, as shown by both the bullish percent index (chart) and the percent of companies over their 50-dma (chart). These moves take time; think 6-8 weeks as opposed to the two weeks since the highs were made.
One immediate indicator to watch is breadth. The washout this week should be followed by an expansion in breadth as a sign investors want back in. That hasn't happened yet. In the past, a 9:1 up day has followed solid bottoms. When that hasn't happened, SPX has moved lower (chart).
Short-term (early next week), a possible inverted head and shoulders pattern should be on your radar (chart).
On the fundamental side, macro continues to be below expectations, although there was some improvement from the G10 (chart). Ed Yardeni has shown the importance of this on SPX revenues, with the upshot that both PMI and exports portend weak sales ahead. With investors strongly discounting earnings growth over 10% in 2014, this is a major watch out. 1Q earnings season is over and EPS growth was just 3.3%.
