S&P 500 Index Due for ‘Stiff Correction’: Technical Analysis

By Shani Raja

Oct. 16 (Bloomberg) -- The U.S. Standard & Poor’s 500 Index may be due for a “stiff” slump as it approaches a resistance level in coming weeks, according to Nader Naeimi, a strategist at AMP Capital Markets, which holds assets worth $75 billion.

The U.S. index’s 62 percent rally from its March low has brought it close to 1,121.4, which Naeimi says represents the 50 percent level Fibonacci analysts identify as a key resistance point. The performance of the index, which closed at 1,096.56 yesterday, is also diverging from measures of price and breadth momentum, pointing to a deeper “correction” than those that have occurred since the rally began, the strategist said.

“The divergences have started to build up over the past few weeks,” said Sydney-based Naeimi, whose firm went to “overweight” from “underweight” stocks in March. “The new highs the index is making aren’t being confirmed by the measures of momentum. The next push higher is likely to extend those divergences, which suggests we’ll see a deeper correction that lasts several weeks or longer, rather than just days.”

The S&P 500 slumped 38.5 percent last year as the financial crisis deepened, tipping nations into a global recession. The index has rebounded from a more than 12-year low on March 9, as government stimulus measures helped calm credit markets and shore up economic growth.

The S&P 500 may climb to the critical 50 percent Fibonacci level in the next few weeks, at which point a slide of between 10 percent and 15 percent is likely, said Naeimi.

Previous Declines

That’s deeper than three previous “corrections” that have occurred since the rally began in March, the strategist said. The first was a 5 percent drop between May 8 and May 15, followed by a 7.1 percent slump between June 12 and July 10, and a decline of 4.3 percent between Sept. 22 and Oct. 2.

“We will see multiple negative divergences as the S&P 500 hits a new cyclical high,” said Naeimi “All the conditions for a stiff correction are in place. The cyclical bull market will continue once the correction has run its course.”

Naeimi applies Fibonacci analysis to the period between the index’s Oct. 9, 2007 high of 1,565.15 and this year’s March low to arrive at the 1,121.4 resistance level.

In technical analysis, a Fibonacci retracement is created by taking two extreme points on a stock chart and dividing the vertical distance by the key Fibonacci ratios of 23.6 percent, 38.2 percent, 50 percent, 61.8 percent and 100 percent, according to Investopedia.com. Once these levels are identified, horizontal lines are drawn and used to identify possible resistance and support levels.

The AMP strategist also uses the relative-strength index, a momentum indicator, to gauge the level of “conviction” at various stages of the rally. For breadth momentum, Naeimi adopts the McClellan Oscillator, which measures how broad-based a rally is in terms of the number of companies involved.

To contact the reporter on this story: Shani Raja in Sydney at sraja4@bloomberg.net.