Head and Shoulders Top and Bonds Signal Downside

  • The S&P 500 is at risk of developing a bearish head and shoulders top, Bank of America said.
  • The S&P 500 could drop as much as 15% to 3800 if the downtrend develops successfully.
  • The bond market and weakening financial conditions point to a further decline in equity markets.

The stock market could be on the verge of a 15% decline as a bearish chart trend develops amid worrying signs from the bond market, Bank of America said in a Tuesday note.

Bank of America technical analyst Stephen Suttmeier is on “head-and-shoulders” watch for the S&P 500, which is a leading downtrend that has been in development for six months.

The pattern takes its shape from a series of three peaks, with the second peak being the highest of the three. A neckline represents the support and is formed by connecting the three bottoms associated with the peaks. When the stock crosses below its neckline, a sell signal is triggered for traders.

According to Suttmeier, the S&P 500 risks forming a bearish top as long as it trades below the 4546-4600 range.”

A decisive break below 4278 at 4222 is the signal to confirm the head and shoulders top with deeper downside risk towards 4000 and even into 3800,” he said.

A drop there would be consistent with Suttmeier’s finding that the median stock market decline in a midterm election year is about 20%, according to the memo.

In addition to the head-and-shoulders pattern, the magnitude indicators are plagued by bearish divergences, financial conditions are weakening, and the High Yield Options Adjusted Spread Index is coming off a large base, which has been a telltale indicator of greater stock market weakness ahead, according to the note.

“The U.S. High Yield OAS breaks above resistance to suggest a one-year risk-free floor for this credit spread. Deteriorating credit conditions are a bearish leading indicator, raising the risk that the S&P 500 completes the top of the head and shoulders,” Suttmeier explained.

But while a peak-to-trough decline of up to 20% would be painful for investors, it would not mean the end of the secular

bull market

in shares. Suttmeier maintains his view that the 2022 theme remains a correction in a secular bull market.

“The weight of evidence suggests a mature cyclical bull market from March 2020 heading towards a cyclical correction (

bear market

) within a broader secular bull market,” he said.

Head and shoulders in the S&P 500

Bank of America

Garland K. Long