The S&P 500 is clinging to a key support level after Friday’s meltdown. Here’s what happens when this fails

Last week’s shocking US inflation numbers continue to rip through markets with dip buyers appearing to be hiding. The hardest-hit Nasdaq 100 futures are down 3%.

Investors are now focused squarely on Wednesday’s Fed earnings, with expectations that the central bank may have to do something bold that will spark even more concern.

The aftermath of Friday’s Wall Street bloodbath left the S&P 500 SPX
Holding on to a key technical support level of just over 3,900. The index is down nearly 19% from the record close of Jan. 3 at 4796.56 and is poised to slide into the technical definition of a bear market on Monday.

Our call of the day by Lori Calvasina, Head of Equity Strategy at RBC Capital, lays out what could happen next, along with sectors that investors could protect a bit.

If the May 19 low doesn’t hold and the index “dips below 3,850 (the outer limit of growth fearful territory, ie the 2011 and late 2018 drawdowns), we see potential downside for the S&P 500 to just above 3,200,” it shares them customers in a new note.

“That would represent a 32% drop in the S&P 500 from the high of early January 2022, which is the average drop in the S&P 500 in the recession from peak to trough since the 1930s,” Calvasina said.

The pandemic’s 34% drop in early 2020 marks a “reasonable place to start thinking about how low the S&P 500 could fall this time in a pullback from the recession.” However, it is equally important to keep in mind that there is priority for US equities to stabilize above this level,” she adds.

For example, recession losses in the early 1980s totaled 17% and 27%, and in 1990 this peak-to-trough move totaled 19.9%. “The 18.7% move down seen back in early 2022 is worse than any of the 1980s drawdowns and close to the 1990 drawdown. A 27% drop would take the S&P 500 to just under 3,500,” he said you.

Aside from Friday’s CPI horror show, Calvasina said his economics team was particularly concerned about a rise in five-year inflation expectations to 3.3% from the University of Michigan consumer sentiment survey released later in the day. Like others, they worry about more aggressive Fed rate hikes that would hurt consumers.

Which stocks could do better in this scenario? Calvasina and the team examined how different sectors within the S&P 500 and the Russell 2000 have traded relative to inflation expectations throughout history.

Within large- and small-caps, they found that energy and financials had the most positive correlations with long-term inflation expectations and outperformed when they rose. Large-cap materials also tend to outperform the S&P 500 in this scenario.

RBC US Equity Strategy, Haver. As of May 2022

Healthcare stocks have had the most negative correlations with inflation expectations for both small and large caps, while consumer discretionary and communications services have underperformed, she said.

Cash: These 19 large-cap stocks are now down at least 60% from their 52-week highs

“The big picture conclusion: this change in long-term inflation expectations could delay what we expect to shift from value back to growth,” she adds.

As for the recession itself, small-cap stocks tend to be hardest hit by recession-related setbacks, but then see strong rallies kicking in in the midst of those downturns, Calvasina notes. Given that small caps are purely domestic games, they should be watched when recession risks are at play.

Calvasina saw an encouraging sign on Friday – the resilience of the Russell 2000 RUT
relative to the S&P 500 as positioning in small-cap futures contracts at asset managers had already fallen well below the GFC lows.

A final word from the strategist – based on history, when a recession hits, some sectors are more likely to be pricing it in than others.

“On May 19 (which remains the S&P 500 YTD low since Friday), declines seen in the S&P 500’s Communication Services, Consumer Discretionary, and Consumer Staples sectors approximated the average declines in those sectors over the past few months seen four broader market recession-related declines. Most other S&P 500 sectors have had significant gaps, with the largest being in energy,” she said.

The Buzz

Cryptocurrencies continued the sell-off over the weekend, with Bitcoin BTCUSD
below $25,000, a level not seen since late 2020. Crypto lending platform Celsius was forced to halt all withdrawals and transfers citing “extreme market conditions” as its CEL digital token plunged nearly 50% late Sunday.

And stocks of technology MicroStrategy MSTR
slumped as Bitcoin margin calls loomed.

Acquisition of the digital world DWAC
slipped 8.2% after Special Purpose Acquisition Company (SPAC), which is buying the company behind Donald Trump’s Truth Social, said it received another subpoena from the SEC related to the deal.

EV startup Electric Last Mile Solutions ELMS
said it filed for bankruptcy a few months after losing its two top executives. It also confirmed an investigation by the US Securities and Exchange Commission.

Asian markets are being hit by both US inflation and mass testing in a densely populated district of Beijing suffering from a “violent” COVID outbreak.

Monday’s data calendar is blank leaving markets simmering in panic this morning. Along with Wednesday’s Fed result, May Retail Sales will be the data highlight of the week.

The markets

Stock Futures ES00

YM00

NQ00
lower as bond sell-off continues with 2-year Treasury note rate BX:TMUBMUSD02Y
is approaching 10-year BX:TMUBMUSD10Y
and again threatens an inversion of the yield curve. Recession Worries Drive Oil Prices CL

BRN00
and the overall energy section lower. Gold GC00
fell while the dollar DXY
engulfs refuge flows and peaks against the yen USDJPY
since 1998.

The graphic

Here’s a breakdown of what’s going on with Bitcoin, from BTIG’s Jonathan Krinsky, who points out that the crypto’s inability to hold $30,000 means it could fall as low as $20,000:

BTIG/Bloomberg

The tickers

These were the most searched tickers on MarketWatch as of 6:00 a.m. EST:

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