Assessing the Technical Damage to the S&P 500

Panic swept across equity markets yesterday as the Federal Reserve (Fed) delivered a hawkish 0.25% interest rate cut, as expected. The real surprise came from upward revisions to inflation projections for next year and forecasts calling for fewer rate cuts. The updated Summary of Economic Projections (SEP) showed policymakers expect core Personal Consumption Expenditure (PCE) inflation to reach 2.5% next year, up from the 2.2% forecast in the September SEP. Furthermore, the median dot plot for the target rate moved up to 3.9% from 3.4%, suggesting Fed officials expect only two 0.25% rate cuts in 2025. Perhaps the real surprise came after Fed Chair Jerome Powell took the podium for his post-Federal Open Market Committee (FOMC) meeting press conference — his commentary overlapped with accelerated selling pressure in stocks. Powell noted that the Fed would need to see continued progress on taming inflation before making additional interest rate cuts.

The S&P 500 sank 3% amid widespread selling pressure. Over 95% of index constituents closed lower on the day, marking 13 straight sessions of declining shares outpacing advancers. However, it is not just daily breadth metrics that have been weakening. There has been a growing list of stocks making new lows across the index, while the percentage of stocks trading above their 200-day moving average (dma) declined to only 56% yesterday, marking a concerning year-to-date (YTD) low.

Yesterday's sell-off created a wave of technical damage, including a short-term uptrend violation and the S&P 500’s first close below the 50-dma in over three months. Regarding additional downside risk, a break below the October highs/November price gap near 5,860 would leave 5,783 and 5,700 as the next major areas of downside support. We recommend waiting for support to be established and for momentum to improve before buying the dip — but most importantly, don’t panic!

The Fed Delivers a Reality Check to the S&P 500’s Rally

Source: LPL Research, Bloomberg 12/12/24
Disclosures: Indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results.

While yesterday’s drop created a host of technical damage, it is essential to remember the longer-term uptrend remains intact. Signs of short-term oversold conditions have also developed in tandem with a potential capitulation in panic-stricken sentiment. For example, roughly 70% of S&P 500 stocks registered new four-week lows yesterday, a historically washed-out reading for a bull market. In addition, the 74% spike in the CBOE Volatility Index (VIX) and the simultaneous move on the futures curve into backwardation (spot VIX priced above future-dated contracts) qualify as contrarian moves.

While some of these measures suggest the worst could be over, other studies imply the damage to breadth could result in more subdued returns in the future. The table below highlights that market breadth has been a statistically strong indicator for future S&P 500 performance. The top quintile group, classified as periods when 81% or more of S&P 500 stocks were trading above their 200-dma, has notably outperformed the lower quintile groups along with the average S&P 500 returns across all periods during this time frame. Unfortunately, the deteriorating breadth of the S&P 500 has recently pushed the index into the fourth quintile group as only 56% of constituents remain above their 200-dma. Returns in this group have historically been below average over the following 12 months.

S&P 500 Forward Returns Based on Breadth Quintiles (1990–YTD)

Source: LPL Research, Bloomberg 12/12/24
Disclosures: Indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results.

Muddied Macro Field Questions

Equity markets were not the only asset class on the move yesterday. Benchmark 10-year Treasury yields jumped 12 basis points on the day and, notably, broke out above the November highs at 4.50%. This is technically significant because it checks the box for a higher high, adding to the growing evidence of a developing uptrend (not to mention that it opens the door for a potential retest of the April highs at 4.74%). As highlighted in the lower panel of the chart below, the U.S. Dollar Index advanced 1% and took out key resistance near 107. The breakout above the longer-term range implies risk is now to the upside for the greenback, a headwind for international stocks — especially for emerging markets — and U.S. multinationals (approximately 41% of S&P 500 revenue comes from abroad, per FactSet).

Upside Risk to Rates and the Dollar

Source: LPL Research, Bloomberg 12/12/24
Disclosures: Indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results.

Summary

Yesterday’s FOMC meeting brought back some unwanted clouds of uncertainty over monetary policy next year. At a minimum, market expectations have shifted toward a shallower- and slower-than-anticipated rate-cutting cycle. However, the Fed cannot take all the blame for the selling pressure as a reality check from overbought conditions, deteriorating market breadth, and rising rates appeared overdue. Technically, the near-term risk remains to the upside for 10-year Treasury yields and the dollar, creating potential headwinds for stocks. Based on this backdrop and the recent technical damage to the broader market, including a notable deterioration in market breadth over the last few weeks, we recommend waiting for support to be established and for momentum to improve before stepping up to buy this dip.