Oct 2, 2022
VOT Research Desk
Key Insights and Analysis
The decline this year is a process of “normalization” following extremely overbought conditions. The largest gap ever recorded existed between prices and the 200-month moving average at the beginning of the year.
Long-term moving averages typically serve as indicators of larger trends. When some of the drivers of overextension change or reverse, prices typically revert to them from extreme overbought or oversold conditions. The distance between the 200-MMA and the index indicates that extreme overbought conditions existed prior to the dot-com crash, Great Financial Crisis (GFC), and Covid-19 selloffs.
This does not necessitate that the index move back toward the 200-MMA; rather, it could well move in the opposite direction while the 200-MMA catches up. Although the MACD indicator is an unbounded indicator, it can be difficult to quantify the extent of optimism or pessimism given how stretched the trend was at the beginning of the year.
S&P 500 INDEX In terms of possible downside for the S&P 500, the 200-week moving average (WMA; now approximately 3,585) is likely to provide a substantial initial cushion. At the high of 3,394 prior to Covid, there is substantial support. The 200-WMA’s sharply ascending slope increases the likelihood that the index will hold the 3,394-3,585 region and rebound from there.
This is due to the fact that the 200-WMA’s slope and average have historically served as a guide during prolonged downtrends. When the index is ascending (the blue annotations on the chart), it tends to rebound from close to the moving average. However, uptrend reversals are frequently preceded by a break below the 200-WMA flattening moving average (red annotations on the chart).The flatness of the long-term average can be thought of as trend “exhaustion” in some way.
NASDAQ COMPOSITE INDEX The Relative Strength Index (RSI) can be used as a guide to determine how far along the current downtrend is. The likelihood that US indices are in the advanced stages of the decline is high using two previous instances, the dot-com and GFC episodes, which were comparable to the decline in 2022 in terms of duration. When the 14-month RSI was close to 30, the index rose again. The RSI is currently around 42
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The Plus and Minus Directional Movement Index (DMI) on the monthly chart are both below 25, indicating range-bound conditions, so it would be premature to conclude that the index is “trending” in the 2020s and 2021s.Because the Minus DMI is higher than the Plus DMI, there may be a slight downward bias within the range.
