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The S&P 500 May Drop To 4,200 This Week

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The S&P 500 May Drop To 4,200 This Week

Stock markets have experienced significant declines since mid-July, and the downward trend may continue. Major indices, including the S&P 500 (SP500), are on the verge of breaking crucial technical support levels, as hopes of rate cuts are transforming into fears of persistently higher rates.

Summer Rally May Have Been a Bull Trap

Recent stock market turmoil suggests that the summer rally might go down as one of the most significant bull traps in the past two decades. Factors such as rising interest rates, a surging U.S. economy, increasing oil prices, and mounting inflation are causing everything to unravel.

Technical Support Breakdown

The S&P 500 is currently teetering on a critical level of technical support at 4,320, which is not only significant for the short term but also the long term as it corresponds to the August 2022 high. A drop below this level would raise doubts about the legitimacy of the entire “bull market” and potentially lead to a retest of the 200-day moving average around 4,190.

Option Positioning Impact

This week, the expiration date for the JPM Collar options contract, a key hedge for the JPMorgan Hedge Equity Fund, could have a significant impact. A put position at 4,210 becomes important if the S&P 500 breaks below the support level of 4,320, acting as a magnet that could pull the index toward it.

Ignoring the Risks of Higher Rates

The stock market’s recent downturn has largely been driven by the significant increase in interest rates. Despite this, the equity market had disregarded these risks and focused on the possibility of future rate cuts. However, the latest Summary of Economic Projections (SEP) suggests that this optimism may not materialize.

Questionable Summer Rally

The summer rally was peculiar from the outset, occurring simultaneously with rising interest rates. This disrupted the long-established relationship between real yields and the stock market. As a result, the TIP ETF plummeted while the QQQ ETF deviated and continued to rise.

Unwinding Volatility Trade

It appears that the entire rally was driven by a short-volatility trade, which is now unwinding. Shorting volatility in an environment of rising interest rates, widening credit spreads, and a strengthening dollar has proven risky. This is reflected in the spike of the VIX index and the CDX high yield spread index.

Possible Bull Trap Unraveling

Given the ongoing technical patterns and market developments, there is a growing possibility that the recent rally is indeed a bull trap, potentially one of the biggest in the past 20 years.