The ongoing trade war between the U.S. and China have dampened investors’ moods, writes Joon Choi

The ongoing trade war between the U.S. and China have dampened investors’ moods in recent weeks.  As major U.S. stock market indices retreat from their record highs in April, there could be major implications if equities do not strengthen towards the month-end this Friday. 

Bearish Formations

The monthly chart of the S&P 500 (SPX) shows that the index made a new historical high in April, but the 19-39 month MACD failed to make a higher high.  As of this writing, the monthly MACD turned down, thus forming a negative divergence against the price. This bearish pattern last occurred in June 2015 (point A), which was followed by two corrections (12% and 13%) in the ensuing eight months.  However, we are still five trading days away from the month-end.  If the index rallies 2.7% to 2,882.94 by next Friday, then the MACD would not turn down and the negative divergence will be avoided. This is the reason for this article’s title “Very important week lies ahead”.  But if we fail to close above the critical level above, then we may have a downside projection of 2,400 (about 16% from current levels).

S&P Divergence

Unlike the SPX, Dow Jones Industrial Average (DJIA) did not make a record high in April, but the index also flashed a monthly negative divergence (Chart 2).  A previous occurrence of this pattern was back in March 2015 (point B) which was followed by two corrections (14% & 13%) in the ensuing 11 months.  The major support level is at 22,400; approximately 12% from current levels.

Doq Jones Divergence

The Nasdaq-100 Index made an all-time high in April and formed a monthly negative divergence against its MACD.  The major support is 6,000, approximately 18% from current level.  This index also flashed the same bearish signal in December 2015; which was a precursor to a 14% correction within two months.  (See chart 3 below.)

Nasdaq 100 Divergence 

The Philadelphia Semiconductor Index (SOX) is showing its first monthly negative divergence since its inception in 1995. Unlike the previous indices discussed, this index is much more volatile which is demonstrated by the 15.6% fall in May.  Its major support level is 1,100, approximately 16% from its current level.  (Chart 4 below)

Semiconductor Divergence

The Russell 2000 Index is a collection of approximately 2000 small companies with a median market-cap of $820 million.  These companies are very sensitive to the state of the U.S. economy as they are not as financially stable as stocks in the S&P 500 Index ($21 billion median market cap).  I am somewhat worried that the monthly chart of IWM (Russell 2000 Index ETF) failed to reach its new highs as the other four indices have done (Chart 5).  Its major support level is 131 which is approximately 13% from current levels.

IWM Monthly

Conclusion

The brewing trade war between the two largest economies in the world may be rattling equity investors but the consequence of the recent drift in stocks may lead to further losses if the stock market does not firm up before the month-end next Friday.  Monthly negative divergences in the major U.S. indices coupled with small-cap stocks showing relative weaknesses may lead to retesting the major supports last December. Table 1 has the critical levels to avoid forming negative divergences for the four indices above.

Critical Levels