Market Recap: Testing Support and Turning Higher
In last month’s newsletter, we left off with the market under pressure. After a sharp drop from the February highs, the S&P 500 had staged a modest bounce that formed a bear flag pattern. At the time of writing, the index had just broken below the lower end of that flag. This breakdown was a key signal that the market was likely headed lower and that risk was elevated.
What followed confirmed that view. The selling intensified as the index fell swiftly through the support levels we highlighted, which included Support 1, Support 2, and Support 3, before finally stabilizing at Support 4. From peak to trough, the decline totaled roughly 20 percent, marking a significant correction.
The market found its footing at support level #4 and began to turn. A powerful rally on April 9, sparked by positive tariff news, pushed the index up more than 9 percent in a single day. Following that surge, price action turned volatile and remained contained below the high of that strong move for some time as the market searched for direction.
Eventually, the index pushed above the high of that April 9 rally. This breakout above the previous high served as the first meaningful signal that bullish momentum was building and that buyers were regaining control.
Charting the Bounce: Bullish Signals Begin to Emerge
Following the steep decline and eventual bottom at Support 4, the S&P 500 has made a meaningful move off the lows. This recovery has started to show important bullish signals and may be laying the foundation for the beginning of a potential longer-term change in trend.
Price Structure
The first encouraging development is the improvement in price structure. On the chart, I have highlighted this with green font, showing the sequence of Low, High, Higher Low, and Higher High. This sequence is a textbook sign of a potential trend change. In downtrends, price typically makes lower highs and lower lows. The shift to a pattern of higher lows and higher highs suggests that the downtrend may be ending and that a new uptrend could be developing.
#1 Reversal
A key moment in this sequence occurred at the higher low, which is marked as (#1 Reversal). This started with a sharp down day where the market gapped lower and closed weak. However, the next day saw a strong shift in sentiment. The market gapped higher, advanced throughout the session, closed the prior day's gap, and finished at the highs of the day. This type of reversal is often an early sign that selling pressure has been exhausted and buyers are stepping in.
#2 Advance Above Downtrend Line
Next, the index advanced above the downtrend line drawn from the February highs, which I marked as (#2 Advance Above Downtrend Line). This line defined the recent downtrend, and moving above it was an early signal that the market's downtrend may be coming to an end, and a potential shift to the upside was underway.
#3 Moving Average Cross
Further confirmation came when the 10-day exponential moving average crossed above the 20-day exponential moving average, shown as (#3 Moving Average Cross). This crossover, combined with price moving above both of these averages, is another bullish signal. These moving averages, which had previously acted as resistance, may now provide support and help stabilize future pullbacks.
#4 Advance Above 50 SMA
Building on that strength, the index moved above the 50-day simple moving average, which I marked as (#4 Advance Above 50 SMA). This moving average is widely watched and moving back above it generally signals a shift toward a more positive short-term outlook.
#5 Next Resistance Level
All of these signals together point to improving market conditions and a decidedly more bullish environment. However, a major test still lies ahead. The index is now sitting just below the 200-day simple moving average, marked as (#5 Next Resistance Level). This moving average often serves as major resistance, especially during bear market rebounds. Many traders view the market as bearish below the 200-day and bullish above it. How the market handles this level will be important. A decisive move above could confirm a trend change, while failure here could mark the end of the bounce.
Bullish Scenario: Building a Launchpad for Higher Prices
Following the encouraging recovery from the April lows, the market is now in a position to potentially make an even stronger bullish move. In this scenario, a breakout above the key resistance level at the 200-day simple moving average would complete the bullish picture. This would represent the final piece of the puzzle and serve as a powerful signal that the market has shifted into a near-term bullish phase. If that occurs, it would make sense to continue increasing equity exposure, as we are already partially allocated toward our total equity target.
One important sign of strength right now is the index holding above its rising 20-day exponential moving average, which I have noted on the chart as "Index Holding 20 EMA." During the decline, the index was trading below this moving average while it was trending lower and acting as resistance. That has now changed. The index is trading above this moving average, which is turning higher. Going forward, I want to see the index continue to hold above the 20 EMA. If it does, this would be a bullish development that signals continued improvement in market conditions.
I have also drawn a projection on the chart labeled "20 EMA Projection" to show where this moving average may trend in the weeks ahead. Ideally, the most constructive scenario would be for the index to hold above the 20 EMA and consolidate just under the 200-day simple moving average. This would allow the moving average to catch up to price, help work off the current short-term overbought condition, and create a more stable base for a breakout. Consolidation here would also give individual stocks time to establish tighter, volatility-contracted basing patterns that could offer lower-risk entry points for new buying.
A straight move higher from current levels and directly through the 200-day moving average would also be bullish. However, that type of move would leave less time for stocks to set up, limit lower-risk buying opportunities, and could leave the index in a short-term overbought condition. This would increase the odds of a pullback not long after the breakout.
Of the two scenarios, a short consolidation followed by a breakout would be the most constructive. If this plays out, it would be VERY BULLISH and likely signal the beginning of a powerful and sustained advance.
Bearish Scenario: Another Leg Lower if Support Fails
While the recent rally has improved the market’s tone, it is important to consider the risk that this recovery could still fail. In this scenario, if the index is unable to push above the key resistance level at the 200-day simple moving average, downside risks would increase significantly.
This chart, which looks similar to the bullish scenario chart, outlines what could unfold if that resistance holds and sellers regain control. The first warning sign would be a move below the 20-day exponential moving average. I have highlighted this on the chart as the first level that, if lost, would suggest short-term weakness is returning.
However, the more meaningful breakdown would occur if the index falls below the key higher low established on the reversal day, which I have also highlighted. This level is important because it marked the point where the market made a stand and began to turn higher. Losing this support would erase much of the recent bullish progress and suggest that sellers are regaining the upper hand.
On the chart, I have also drawn arrows and labeled the potential path lower if this scenario plays out. A break below the 20 EMA and then the reversal day would set the stage for a likely third wave lower. This would mirror the pattern of the two previous sharp legs down, which I have also marked on the chart for reference.
In this bearish scenario, a decisive break of these support levels would likely lead to another strong wave of selling, pushing the index below its recent low and confirming that the market is still in a corrective or bearish phase.
Summary
As we review all of the technical evidence, I believe the odds favor a bullish resolution. In other words, while risks remain, the higher probability scenario points to the market eventually pushing above key resistance at the 200-day simple moving average. If that occurs, it would confirm the improving market conditions and likely open the door to higher prices ahead.
That said, it is important to recognize that technical analysis does not provide certainty. Instead, it helps us assess probabilities and define expectations. Markets are dynamic and influenced by many factors, including unpredictable news events such as tariff negotiations, which can quickly shift the landscape. Because of this, our approach must remain flexible.
The way I view it is simple: we play the odds, allocate accordingly, and stay ready to act as conditions evolve. If the market confirms strength by advancing through key resistance, I will continue to increase equity exposure to take advantage of the bullish environment. On the other hand, if the market fails and breaks below important support levels, I will become more defensive to protect client capital.
In this type of environment, success comes from respecting the signals the market gives us, playing the higher probability outcomes, and being ready to shift gears when the evidence changes.
Current Account Update
When market conditions turned bearish at the beginning of the downturn that started in February, I acted quickly to reduce equity exposure. By moving out of stocks early, we protected our capital and avoided much of the downside. As a result, we are now in the advantageous position of gradually redeploying capital with flexibility and our account values largely intact.
At this point, client accounts have approximately 40% of their total equity allocation invested. This exposure was added last week as the market began to show signs of improvement.
Looking ahead, my approach remains tactical. If the bullish scenario outlined in this newsletter plays out and the market breaks above key resistance levels, I will continue to increase equity exposure to take advantage of improving conditions. However, if the market weakens and breaks down through important support, I will shift back to a more defensive posture to help protect against downside risk.