“Brace for a severe correction” analyst warns on S&P 500, SPY ETF

By:
on Oct 23, 2023
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  • The S&P 500 index has dived deeply in the past few weeks.
  • Analysts are warning about the dire state of American stocks.
  • The focus shifts to the upcoming big tech earnings.

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American stocks have recoiled in the past few weeks as concerns about monetary policy and geopolitical issues rose. The S&P 500 index, which tracks the biggest 500 companies in the US, ended last week at $4,225, much lower than the year-to-date high of $4,600. 

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Similarly, ETFs that track the S&P 500 like SPDR’s SPY and Vanguard’s VOO have also dropped by almost 9% from the highest level this year. Other American indices like the Dow Jones and the Nasdaq 100 have also dropped sharply recently.

Why the S&P 500 is diving

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Some analysts are warning that the S&P 500 is ripe for a deeper dive. The major risks for the index are the ongoing geopolitical risks in the Middle East and the rising energy prices. There’s increased fears that the crisis in the Middle East will escalate. During the weekend, the US urged its staff in Iraq to evacuate for now.

The implication of this crisis is that the price of crude oil will continue soaring. Brent has already surged from $60 a few months ago to $95. In a recent note, analysts at JPMorgan warned that crude oil will soar to $150. UBS has a price target of $145. 

As a result, there is a likelihood that inflation will remain at an elevated level in the coming months. This, in turn, will push the Federal Reserve to maintain a hawkish tone in the coming meetings. The Fed has already pushed rates from zero to 5.50%.

Higher interest rates have pushed bond yields to the highest level in more than two decades. As a result, short-term assets like money market funds have become more attractive to many investors.

There are also fiscal challenges. Data by the Treasury Department showed that the US budget deficit widened to over $1.7 trillion in the last fiscal year. This situation happened as government spending rose while tax revenues dropped.

A deeper correction is coming

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In a note, a popular Twitter user warned that the S&P 500 could take a deeper dive in the coming weeks. He expects that the index could drop to $3,950, implying a 6.30% decline from the current price. He pointed to the disappointing breadth, where most companies in the index are in the red.

Other analysts have also pointed to the performance of the Magnificent 7, which helped to power the recent S&P 500 index surge. An index that tracks the biggest 7 companies in the index has formed a triple-top pattern, one of the top signs of a reversal.

Further, the weekly chart below shows that the SPX index has formed a double-top pattern. In price action analysis, this pattern usually leads to a deep correction. Therefore, if it works, the next level to watch will be at $3,497, the lowest swing in October last year. This price is about 17.20% below the current level.

S&P 500

SPX chart by TradingView

The next key catalyst for the SPX index will be big tech companies by the likes of Microsoft, Amazon, Meta Platforms, and Alphabet. These results will come a week after Tesla published weak earnings, pushing its stock down by over 10%.

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