Stock market: A pullback may still be coming, analysts say

Traders work on the floor of the New York Stock Exchange.
Getty Images
Traders work on the floor of the New York Stock Exchange.

Despite some recovery from a washout that sent the S&P 500 to a two-month low, technical analysts are expecting further pullback in the volatile market.

"Momentum post-Brexit (is) starting to deteriorate," said Baird Investment Strategist William Delwiche, who focuses on technical trends. He referred to the period since late June when the United Kingdom rattled markets by voting to leave the European Union.

He also pointed to excessive optimism and a breakdown in short-term market breadth, or the portion of the stocks in the index that are showing a positive trend. "We need to see those patterns reverse," he said.

A rise in volatility, mostly to the downside, has investors on edge over whether a correction is coming. The stock index is in the second-longest bull market ever and at historically high valuations, but there's concern that earnings growth may not be strong enough to sustain those levels.

A potential catalyst for a sell-off or rebound is coming next week, when the Bank of Japan and U.S. Federal Reserve hold separate meetings, on Tuesday and Wednesday. Investors await any announcements on Japanese stimulus, and indications on whether the Fed will raise interest rates later this year.

Katie Stockton, chief technical strategist at BTIG, expects the pullback in stocks to continue ahead of the Fed meeting.

"I think investors might be rewarded by waiting a few days, but not much longer than that, based on indicators," she said. She said that almost 50 percent of the S&P 500 stocks are now oversold, according to a proprietary metric used by BTIG, but the broader index has not yet reached that condition.

Source: BTIG

Stock market volatility has also kept the S&P 500 above key support levels, indicating that a pullback will likely be shallow, analysts said.

Sameer Samana, global quantitative strategist at Wells Fargo Investment Institute, said "2,100 — that's going to be the strongest support. If you get below that, it gets a little dicey, then you get into the 200-day moving average (around) 2,058."

The S&P 500 dropped 2.45 percent to 2,127.81 last Friday, for its worst day since June 24, when global markets plunged following the surprise U.K. vote to leave the European Union. The S&P 500 closed a touch lower Wednesday but jumped about 0.9 percent in intraday trade Thursday to near 2,144.

"If you were to get below the 2,100 area, some risk management is probably prudent," Samana said, saying that at that point, investors shouldn't own more equities than they need to.

The next level analysts say to watch is the post-Brexit low of 1,991.68, or roughly 9 percent below the all-time intraday high hit in August.

"While we could have a correction here, it's not the first leg of a protracted downturn," said Baird's Delwiche. He said he is watching the range between 2,120 and the 200-day moving average around 2,060 for support.

"We have this bullish backdrop," Delwiche said, pointing to a breadth indicator that shows more than 70 percent of industry subgroups remain in an uptrend, versus only 12 percent at the February low. "I think probably if we look at it, we will end up seeing we make a low before the election and turn higher."

By the numbers: Analysts' predictions

To be sure, a one or even two-day breach of key support levels doesn't necessarily mean the stock market is in for further, sharp declines.

"Seasonally, you'd expect further downside," Stockton said. But she said she expects any pullback to be "shallow and short-lived" since "the S&P 500 and other major indexes broke out to all-time highs this summer."

"While we have the weak short-term momentum, we have strong long-term momentum," she said.

Stockton projects that the S&P 500 will reach 2,400 in the next six to 12 months. Wells Fargo Investment Institute sees the index hitting a range of 2,190 to 2,290 by the end of the year.

Of 15 major Wall Street banks CNBC surveyed, including Wells Fargo, the average year-end S&P 500 target is 2,177. While below the all-time intraday high of 2,193.81 hit August 15, that average target is a 2.4 percent upside from Wednesday's close.

"Now there's minor resistance at the high, 2,194," Stockton said. The S&P 500 "only tested that once. Beyond that, there's no resistance left on the chart."

The CBOE Volatility Index (VIX), considered the best gauge of fear in the market, spiked above 20 Monday to hit its highest since June 28.