Rising risk aversion, a surging U.S. dollar, historical seasonal weakness and a climb in bonds could send theS&P 500 down as much as 21 percent from Friday’s close, according to Mary Ann Bartels, Bank of America Merrill Lynch’s technical research analyst.
The 2-year Treasury yield could drop to zero, Bartels added.
“There is still a chance that 1100-1020 holds, but the risk is now higher, or a 50 percent probability, that the S&P tests 985 – 910,” wrote Bartels, who is often chosen among the top chart analysts in an annual survey by "Institutional Investor" magazine. “September historically is the worst performing month in the year, while October traditionally marks important market bottoms.”
The S&P 500 is already down 15 percent from its bull market high hit at the start of May. Bartels believes that the benchmark will retest the 1100-1020 area and if it fails there, then look out below. She gets her target in the 900s using a combination of commonly-used factors, most notably a 61.8 percent Fibonacci retracement of the March 2009 to May 2011 rally.
The CBOE volatility index —nicknamed “The Fear Gauge”—has jumped 40 percent since the start of August. The CBOE put/call ratio, which measures the total volume of put options versus call options, is jumping as well, signaling investors are buying more and puts to hedge against a fall in equities, points out Bartels, whose gained a reputation for her deep analysis of holdings by hedge funds and speculators.
What’s more, the problems in Europe are causing a flight to safety into the U.S. dollar , which has a very tight inverse correlation with equity markets at this stage. Despite the downgrade of U.S. debt earlier this year by S&P, the dollar still represents the risk off trade.
As for bonds, Bartels makes a simple channel around the past highs and lows of the two-year yield. The bottom part of the channel leads right down to zero percent, meaning investors will keep buying these notes and expect nothing in return except their principle. She sees a similar drop in the long-end of the curve with the 10-year Treasury yield going as low as 0.3 percent.
This flattening of yield curve will only hurt banks’ ability to make money on lending over time.
“I fear she is right on point,” said Chris Verrone, a chart analyst for Strategas Research, who correctly got bearish for his clients recently. “The biggest takeaway from me over last few weeks is continued deterioration in credit.”
Goldman Sachs broke $100 for the first time since March 2009 on Monday as financials continue to fall at a more rapid rate than the rest of the market. European banks are already at their 2009 lows.
“If the financials are the ‘tell,’ they are on their way to revisiting the '08 - '09 lows,” said Stephen Weiss, a hedge fund manager for Short Hills Capital. “Europe does bear a scary resemblance to the last U.S. financial crisis and will drive down indices.”
Bartels suggests buying consumer staples, mining stocks and betting against consumer discretionary stocks to protect from the decline and volatility.
“The violent swings within the market are more typical of a bear market than a bull market,” she said.
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