The S&P 500 is on the verge of a technical breakdown. Here's the sell signal to watch for.
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- The S&P 500 is on the verge of a technical breakdown, according to Fairlead Strategies' Katie Stockton.
- Stockton said that 4,180 is a key support level that needs to be preserved to prevent further selling.
- Extreme sentiment readings suggest to Stockton that a reversal in stock prices could be imminent.
The S&P 500 is on the verge of a technical breakdown, but Fairlead Strategies' founder Katie Stockton says don't sell stocks just yet.
That's because oversold extremes are flashing for certain indicators, suggesting that a rebound could be imminent.
"The downdraft has the potential to yield a breakdown, but we would not sell into weakness with signs of intraday downside exhaustion supporting a rebound that could preserve support, or at least yield a better selling opportunity," Stockton said in a Thursday note to clients.
Stockton is closely watch the support range of 4,180 to 4,195 on the S&P 500. A decisive breakdown below 4,180, typically marked by two consecutive weekly closes below that level, would be the signal to Stockton that the current risk-off nature of the stock market is set to extend and drive stock prices even lower.
Stockton's support range for the S&P 500 slightly differs from the closely watched 4,200 level among technical analysts. Here's what Stockton had to say about that on Wednesday.
"We have to look at these support levels as cushions, not precise points. They never are precise in that there's just too many market participants to allow them to be that. Our support zone is actually 4,180 to 4,195, so it's a bit lower than that 4,200 threshold," Stockton told CNBC on Wednesday.
If 4,180 fails to hold as support for the S&P 500, Stockton identified 3,920 as the next support level to watch, which represents potential downside of 6% from current levels.
The S&P 500 traded below 4,180 for the first time since June on Thursday, trading to as low as 4,151.
But for now, Stockton is anticipating a potential reversal in stock prices in the near-term.
"We would not assume a breakdown will occur, noting oversold extremes are prevalent not only in price, but also in breadth like the percentage of stocks above their 50-day moving averages," Stockton said.
About 17% of S&P 500 stocks are currently trading above their 50-day moving average, which is a level that has been consistent with bottoms during market corrections in the past.
The missing ingredient for a stock market recovery right now, according to Stockton, is a consolidation in interest rates. If interest rates can stop moving higher, that would be a good sign that stock prices can stage a recovery.
"The elevated level of the VIX shows fear in the market, so a reversal could be abrupt. We believe consolidation in yields is needed to instill a shift in sentiment, and our indicators suggest that yields may see a prolonged consolidation phase," Stockton said.
The 10-year US Treasury yield fell six basis points on Thursday to 4.89%, but it has been consistently testing the 5% level for the past week. If the 10-year yield jumps above 5.04%, that would be a further signal to Stockton that weakness in stock prices could persist.