Consumer Sentiment May be the Crytal Ball for Predicting S&P Returns

I keep hearing about the danger of Think Positiveinvesting in the US stock market after recently hitting an all-time high. Since that all-time high, the US market, as measured by the S&P 500, has flattened out and decline slightly. Its quite possible there could be a pullback in the coming weeks or months, but it doesn’t look like it will be much of a correction.

Investors waiting to get in to the market may as well start wading in slowly. Can the market decline further? Sure, but I’ve never been very good at timing the market and if you haven’t retired already with millions of dollars in your investment account, there is a good chance you haven’t been successful at timing the market either.

When the Stock Market Correction Comes, How Bad Can it Be?

What does a market correction look like?

Let me first start by saying I am long-term bullish on equities. But after witnessing a record high Dow that exceeded 17000 and an S&P 500 index on the cusp of breaking 2000, I started wondering how much further this market can climb before it ‘corrects’, as the industry terms a sharp decline after a seemingly continuous ascent—as if the current market value is ‘incorrect’.

We know why it happens—the correction that is. Investors may be taking profits, rebalancing, or just simply be nervous of the subsequent crash after a trancelike high.

There are many more economists and analysts that think the correction is imminent than there was just a few months ago. In my opinion there isn’t a question as to whether the correction will come, but rather, when will it finally appear and how bad will it be?

At PM101, we invest based on fundamentals, but it doesn’t hurt to understand the technicals of the market or a particular investment. And while I’ll disclose that we are not experts here, we have become quite skilled at using technical analysis to complement our fundamental work.

So when do we think the correction will happen and how bad will it be? Well, it’s quite possible we may already be in the correction, even though we don’t think that is necessarily the case. But if the market is going to be correcting soon, we could see two possible scenarios play out. There seems to be some support at around 1950, shown by the top horizontal line on the top right of the chart below. The S&P could very well reach that level and bounce, but that level isn’t low enough to be termed a correction.

The second horizontal line shows another support level at around 1930, which coincides with the 50-day moving average. This looks like an important level. If the index breaks that level, we may very well be in the long-awaited correction.

S&P 500 Chart

If the S&P 500 index breaks below 1930, we may see the index decline all the way down to around 1860. The chart below highlights the next level of support at these levels. A decline to 1860 would result in a 6% decline from the 1985 high reached earlier this month. If this is the extent of the correction, we should consider ourselves lucky.

S&P 500 Chart

We’ve seen these levels of pullback before, and it is not the correction that you read about in the media. The correction talked about in the media is much deeper and can be scarier than just a 6% decline. The chart below shows two more support levels at 1810 and 1760. If the market reaches 1760, we can officially (as proclaimed by PM101) consider the market to be corrected. These levels would result in a decline of over 12% from the S&P high and would probably ignite new buying interest.

S&P 500 Correction Chart

However, a word of caution—a 12% decline in the market may spook investors to dump shares for fear of the market entering a bear market. If this were to happen and the market breaks through the 1760 level, it could drop all the way down to 1650!!! That’s a scary thought indeed.

In our humble opinion, we think there is a bit more upside to the market before we see the 10%+ correction that is anticipated. That being said, we are cautious that the correction may come sooner rather than later.