The Stock Market Had a Crazy Good Week. One Way to Make Sense of It All.

Traders prefer a volatile market, and they’ve gotten one in 2022. Stocks have declined, rallied, and dropped again, driven by ever-evolving expectations for interest rates and inflation, shifting recession odds, and the outlook for corporate earnings. About the only thing that has been reliable has been the technicals.

Yes, the technicals. This past week’s rally lifted the Dow Jones Industrial Average 2.7%, the Nasdaq Composite 4.1%, and the S&P 500 index 3.6%. That’s after all three saw declines of at least 3% during the prior week, their third straight losing week.

What stands out is where this past week’s rally started—when the S&P 500 hit 3900 on Tuesday. That’s not only a big round number, but also equal to the 61.8% Fibonacci retracement level off the June lows (that is, 61.8% of the way from the market’s trough to its prior peak). That the index even needed to bounce was because it had dropped 9% from its 200-day moving average near 4300, which is where stocks had stopped after rallying 17% off their mid-June low just above 3600. The oft-maligned charts have fit like a glove.

So where to next for the S&P 500? Numerous technical analysts see a trading range of 3900 to 4300 as most likely in the near term. A break below 3900 would put 3800 as the next support level, and then the June low of 3636 comes into play. A rise above 4300, however, could signal more gains to come and a change in the market’s tone, writes J.P. Morgan technical strategist Jason Hunter.

That’s a big if. Keith Lerner, Truist Advisory Services’ co-chief investment officer and a chartered market technician, expects a continued stabilization in the very near term, given the magnitude of the previous weeks’ declines, the depressed sentiment, and the recent selling that has left portfolio managers light on stocks.

But over the coming months, he recommends trimming back holdings whenever the S&P 500 approaches its 4300 resistance level, still near where the index’s 200-day moving average sits. It’s also where the S&P 500 would be trading at 18 times price/earnings, which has been the peak in recent months.

“I think it’s somewhat optimistic to say we’ll get back up there anytime soon,” says Lerner. “It’s a really strong cap right now, given the amount of earnings uncertainty that you have.”

Since mid-June, analysts’ estimates for third-quarter S&P 500 earnings have declined by 5.5%, according to Credit Suisse data, despite a better-than-expected second-quarter reporting season. Estimates for 2023 have held up better, down 3.7% since mid-June, but there are reasons to believe they will decline more. The Federal Reserve’s jumbo interest rate hikes in June, July, and September will begin to flow through to the real economy in the coming quarters, a recession in the U.S. remains a possibility, and economic weakness in Europe and China will hurt multinationals’ earnings.

Faced with all the uncertainty in the outlook, analysts might not be updating their 2023 forecasts just yet, instead focusing on the here and now of the third quarter. Should those forecasts fall further, the top of the S&P 500’s trading range could come down too.

For now, though, technicals will likely continue to dominate. The next major catalyst for the market will land on Tuesday morning, with the release of August’s consumer price index. A tepid pace of inflation could send stocks higher to meet resistance, while a hotter print could see them smash through support.

Either way, it’s a trader’s market. The rest of us are just investing in it.

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com