Stocks tumble as selling continues… but a rebound looks overdue

After another 7 per cent drop in Chinese shares overnight, trading was halted for the second time this week despite the government’s rescue efforts. This time, the session ended after only 30 minutes. Equity market traders got spooked, leading to further big drops in global stock index futures. The European stock markets were down between 2 to 3.5 per cent at midday in London, while US index futures were down about 2 per cent ahead of the Wall Street open, with shares in Apple down 3% in premarket to fall below the important $100 mark.

So, there’s still no end in sight for the sell-off, but this could change any minute of course. Traders will need to be alert to the possibility of an unexpected rebounded, especially since the markets are looking severely oversold in the short-term. Added to this, the latest economic data has not been too bad when you take the Chinese manufacturing PMI out of the equation. The Eurozone unemployment rate, for example, unexpectedly fell to 10.5% from 10.7% previously, although retail sales disappointed with a drop of 0.3% month-over-month. Earlier today, German retail sales also disappointed expectations with a rise of 0.2% month-over-month, but more importantly factory orders showed a big jump of 1.5%. In the US, the latest employment indicators that have been released so far this week suggest we may see another stellar jobs report on Friday. As well as economic data, stocks may find support from the upcoming US earnings season which unofficially kicks off next week. So, there may be light at the end of the tunnel for the equity markets.

From a technical point of view, the S&P 500 and European stock indices have reached or neared significant support levels. Given the extent of the recent drop, we think that a modest bounce at these levels is likely at the very least. The sellers may book profit, while the frustrated bulls may decide it is time to step in again. In theory, the combination of short-covering and possibly some opportunistic buying pressure could provide support to the markets. However, so far there’s little evidence to suggest the buyers have stepped back in. Thus, bullish speculators may wish to wait for some sort of confirmation before concluding that the selling pressure has ended.

As I mentioned in our previous S&P 500 article on Monday (see “Global stocks tumble as 2016 trading begins,” for details), the 61.8% Fibonacci retracement level of the bounce from the August 2015 low around 1942 was our main bearish target; this level is being tested as we go to press. Given that there is also a 161.8% extension level converging around here, at 1938, we have a potential Bullish Gartley pattern in the making. Meanwhile, the RSI has almost reached the 'oversold' threshold of 30, which suggests that the bearish momentum may be about to peak.

If the S&P does bounce back from here as the abovementioned technical signals suggest, then a rally to previous support at 1980 or even the key 1994-2000 area would become highly likely. What happens next will depend on price action there as well as sentiment at the time. In any event, bullish traders may wish to wait for some sort of confirmation here before jumping on the bandwagon, because there is a risk for a much bigger move lower. Indeed, if the sellers refuse to ease pressure and the index moves below the 1938-42 Fibonacci-based support range then fresh selling could emerge, leading to a possible move towards the next Fibonacci or other support levels shown on the chart. The August low at 1834 would then become a realistic bearish target. It is also possible that in the case of a rebound from the aforementioned support at 1938-42, the index could run into renewed pressure once it arrives at important resistances shown on the chart. So, one should proceed with extreme caution.