S&P 500 May Retreat as Bank Advance Weakens: Technical Analysis

By Elizabeth Stanton

Oct. 7 (Bloomberg) -- Banks and technology companies that outpaced the Standard & Poor’s 500 Index as it rose from a 12- year low are beginning to lose momentum, suggesting the market may retreat 10 percent, according to MKM Partners.

A gauge of 79 financial companies in the S&P 500 is beating the broader index by 1 percentage point since Aug. 5, while technology stocks are exceeding it by 0.7 point, data compiled by Bloomberg show. Between March 9 and Aug. 5, the bank gauge added 126 percent, the computer measure rose 58 percent, and the S&P 500 climbed 48 percent, the data show.

“The loss of relative strength is something that supports a correction,” Katie Stockton, chief market technician at Greenwich, Connecticut-based MKM, said in an interview. “What happens on a relative basis is often an early indication of what might happen on an absolute basis.”

Technology and financial stocks are the largest of the 10 industry groups in the S&P 500. Financial shares led the index’s rebound since March 9 as credit markets thawed and the biggest U.S. banks said they were profitable to start the year. Technology shares are the best-performing industry in 2009 as investors buy companies that sell products in faster-growing markets outside the U.S.

A retreat by the S&P 500 would likely stop before it reached 945, a 10 percent drop from yesterday’s close. That level is significant, Stockton said, because it’s near the S&P 500’s intraday high on Jan. 6, which remained its peak for the year until June 1 as the index plunged as much as 29 percent.

Stochastics Range

The end of the retreat might coincide with a majority of stocks in the S&P 500 falling too fast relative to a recent trading range defined as “stochastics,” Stockton said. About 35 percent of the S&P 500 companies are oversold based on stochastics, she said. Investors should wait for an increase to 55 percent “before diving back in,” she said.

Following the correction, the S&P 500 is likely to rally to at least 1,220, a 16 percent rally from today’s close, Stockton said.

A decline is likely in the next two weeks because the S&P 500 last month had what technical analysts such as Stockton, who base predictions on price and volume charts, term a failed breakout. The index closed above 1,054, a key resistance level, on the third Friday of the month, then failed to top it at the close on either of the next two Fridays.

“Usually failed breakouts are followed by corrections,” Stockton said. “Combine that with October’s seasonality being quite weak, and I think the market’s set up for a correction this month.”

Some of the biggest declines in U.S. stock market history occurred during the month of October, including the crashes of 1929 and 1987. The S&P 500 fell 17 percent last October, its worst month of 2008.

To contact the reporter on this story: Elizabeth Stanton in New York at estanton@bloomberg.net