Andrew Kelly/Reuters
- The stock market could have more downside ahead after Monday's Evergrande-induced meltdown, according to technical analyst Katie Stockton of Fairlead Strategies.
- Stockton has her eyes on the stock market's fear gauge to sense if more downside is likely.
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The stock market could still have further downside ahead if the Volatility Index closes above the key 25 level for the second day in a row, according to a Tuesday note from technical analyst Katie Stockton of Fairlead Strategies.
Stockton is keeping an eye on the market's fear gauge as investors assess the damage from a potential default of China's second largest property developer, Evergrande.
The potential insolvency risk for Evergrande sent the S&P 500 down as much as 3% yesterday after it became clear that the company may be unable to meet its upcoming debt payments of $83 million on Thursday. Now many market participants are wondering if Evergrande's $300 billion in liabilities could represent a systemic risk to markets.
According to Stockton, the S&P 500's decisive close below its 50-day moving average on Monday means secondary support at 4,238 is in play, representing potential downside of 3% form current levels.
"The 5% pullback is differentiated negatively from other dips below the 50-day moving average in that the indicators have seen notable deterioration. The daily MACD indicator is in negative territory and the weekly stochastics have fallen from overbought territory, increasing risk of downside follow-through," Stockton explained.
Monday's price action is comparable to the March 4 low, in which the S&P 500 fell decisively below its 50-day moving average. But that price action was reversed on March 5, when the S&P 500 jumped back above its rising 50-day moving average.
"Should we see the same from the S&P 500 today, that would indicate that the pullback has matured already. Otherwise, we would brace for a breach of the cloud and test of secondary support," Stockton said.
Despite Tuesday's relief rally of about 0.5%, the S&P 500 still remains 1.5% below its 50-day moving average.
Stockton is watching the 25 level on the VIX to sense if more downside is likely.
"We would be concerned if the VIX closes above 25 for two consecutive days because that would hold bearish implications for the inversely correlated S&P 500," Stockton concluded.
As of Tuesday afternoon, the VIX traded at 23.57 and hit an intraday high of 25.60.
