What happens if - just as it did in Aug 2015 and Jan 2016 - the S&P 500 starts caring about Chinese stocks? The answer, as BofAML's Stephen Suttmeier explains, is "nothing good."
The rallies for the Shanghai Comp (SHCOMP) and S&P 500 (SPX) both started with double bottoms off January/February lows and both could end with head and shoulders tops off the March-May highs. The SCHOMP broke 2900 on May 9 to confirm its head and shoulders top and the S&P 500 moved closer to support at 2039-2033, where a downside break would confirm its head and shoulders top.
SHCOMP below 2900 = bearish signal
The break below 2900 on the Shanghai Composite (SHCOMP) confirms a head and shoulders top that increases the risk for a retest of the January / February lows at 2638. Given the larger downtrend, we cannot rule out additional lower lows toward the prior highs from 2012-2013 near 2500-2440. Filling Monday’s downside gap and nearby resistance at 2900-3013 is needed to call into question the bearish setup on SHCOMP.
SHCOMP: early May = early Jan = late Aug
The early May breakdown on the SHCOMP could have bearish implications similar to that of the double top completed in early January and the triangle breakdown from late August. In other words, China could become a problem for global equity markets once again. Should the SHCOMP Comp remain weak and the S&P 500 start to care about China’s equity market, the S&P 500 should see a deeper decline. The chart above shows the S&P 500 drops after the August 20 and January 4 breakdowns in the SHCOMP. This is a risk factor for the S&P 500.
Risk: head & shoulders top on the S&P 500
A double bottom started this rally in the S&P 500. Does a head-and-shoulders top end it? The S&P 500 has stalled at 2075-2085 resistance last week. While below this resistance, the risk is for a head-and-shoulders top off the late March-to-early May peaks. The S&P 500 closed below the rising 50-day MA near 2055 on Friday, but it would take a decisive loss of support at 2039-2033 to confirm the head-and-shoulders top and suggest a pullback to 2012-1997 (200/100-day MAs) and 1965-1950 (top projection and February double-bottom breakout point). A decisive push above 2075- 2085 is required to negate this potentially bearish tactical setup for the S&P 500.