After Posting New Highs, Major US Equity Indices Come Under Pressure Last Week, Landing Right On Important Support

Charolais, Bull, Cattle, Sky, Animal

Major US equity indices posted new highs last week, but only to reverse and give back those gains. By Friday, the S&P 500, the Nasdaq 100 and the Russell 2000 were all sitting on channel support. Bulls cannot afford a decisive breach, as it can lead to a self-fulfilling prophecy, given the massive rally from last March and given how lopsidedly bullish several metrics are.

The 4Q20 earnings season is 43.4 percent through. Earnings are coming in better than what was expected at the end of the quarter. But stock reaction has gone the other way.

When 4Q ended, the sell-side expected S&P 500 companies to bring home $36.05 in operating earnings (arrow in Chart 1), having bottomed at $35.43 in late September. As of last Thursday, these companies had rung up $37.18 in blended earnings, although down a full dollar from a week ago.

As a result, 2020 estimates are now $121.37, versus $122.37 a week ago, while 2021 estimates rose from $167.01 to $169.39. If these estimates come through, earnings will have grown a handsome 39.6 percent this year!

Leading up to this, stocks rallied massively. The S&P 500 (SPX) jumped 11.7 percent last quarter. From the low of last March, the large cap index rallied 77 percent.

Given the massive move, it is not uncommon to witness weakness on occasion. Last week, the S&P 500 (3714.24) shed 3.3 percent, reversing hard from Tuesday’s fresh intraday high of 3870.90. Although not alarming just yet, a couple of things are worth consideration.

First, the weakness transpired not because earnings are coming in worse than expected rather investors are turning a blind eye to it, which suggests new money is hesitating to buy at this level.

Second, of late there have been subtle signs of fatigue. Last Monday, a hanging man formed, which was preceded by back-to-back dojis. Then came Tuesday’s reversal after posting a new high. By Friday, the index closed right on the 50-day moving average (3715.95), which approximates a rising trend line from last March (Chart 2). If this dual support gives way this week, bulls have an opportunity to put their down at 3640s, which is where the index peaked on November 9 when Pfizer (PFE) announced its positive vaccine news. A loss of this level can quickly result in a test of 3580s; the S&P 500 peaked at 3588.11 on September 2 before correcting over 10 percent in three weeks.

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