A trader points to monitor displaying an S&P 500 Index (SPX) chart on the floor of the New York Stock Exchange (NYSE) in New York, U.S. (Photographer: Michael Nagle/Bloomberg)

Charts Take an Ominous Turn for S&P 500 With February’s Floor Under Siege

(Bloomberg) -- A chart level that most investors thought would never be tested again in 2018 is shaping up as its best hope after U.S. stocks staged their worst back-to-back declines since October.

It’s 2,532.69 on the S&P 500, the intraday bottom touched on Feb. 9, and until Monday the lowest trading level of the year. It was briefly breached in the last 15 minutes before the index finished at 2,546, down 54 points to the lowest level since October 2017. The Dow Jones Industrial Average plunged 508 points, and the Russell 2000 ended 21 percent below its August record.

Charts Take an Ominous Turn for S&P 500 With February’s Floor Under Siege

To Russ Visch at BMO Capital Markets, it was just a matter of time before the February support caved in. One after another, past floors have given way as the sell-off deepened. Since the rout started in October, the index has fallen below its averages of the past 50 and 200 days. The latest breakdown came last week at 2,630, a level that had served as a cushion twice in the last two months. The April intraday low cratered Monday.

Visch says more pain is likely, citing a technical model called “measured move” that says, essentially, that downtrends get worse once a bounce fails.

“A move to 2,445 makes a lot of sense to us,” Visch wrote in a note to clients. “A close below the early 2018 lows will likely cause the ‘rush for the exits’ which brings the heavily negative, one-sided bearish climactic action that’s been missing so far.”

Visch is among a group of chartists whose constant warnings against buying the dip over the past month has proved prescient. One key missing ingredient for a market’s bottom to form is investors capitulating, they’ve argued.

Signs that investors are giving up on equities have started to surface according to Mike Wilson, chief U.S. equity strategist at Morgan Stanley. From a slump in hedge-fund leverage, near record withdrawals from equity funds and a jump in cash holdings at retail brokerage accounts, risk aversion has reached levels that set the stage for a rally, said Wilson, who expects the S&P 500 to trade in a range of 2,400 to 3,000 next year.

But in the event that last week’s low of 2,583 failed to hold, as in the case now, investors should prepare for a “quick move” to 2,450, he said. During the next leg down, companies with elevated valuations, such as software makers, consumer discretionary shares and some heath-care stocks, will likely bear the brunt of the selling.

“Once that occurs we would then expect a violent rotation toward cyclicals, out of defensives,” Wilson wrote in a note to clients. “With both buyside and sellside expectations now more realistic about next year and shock prices reflecting that, we think we are finally set up for a rally, something we have avoided all fall.”

©2018 Bloomberg L.P.