One key S&P 500 metric could spell more bad news for stocks

There’s a lot for stock investors to digest in the markets right now, between an upcoming Federal Reserve meeting this week, the potential for higher taxes, and the implications of China’s Evergrande debt crisis.

Investors were clearly in a bearish mood on Monday, with the S&P 500 trading roughly 2.7% lower as of afternoon trading. But one metric that’s been a comfort to optimistic investors this year is in the red zone, and that could spell more trouble ahead: namely, the prized 50-day moving average.

The metric is often viewed as a bullish short-term line in the sand if stocks manage to trade above the threshold consistently (as the S&P 500 has done for months now). “If [the index is] heading higher, and it’s above its 50 [day moving average] and the 50 is above its 200 [day moving average], then it’s like, ‘Okay, all systems go,'” CFRA’s chief investment strategist Sam Stovall told Fortune. “But when the market comes down to test that 50 day moving average, then it’s a sign that, ‘Okay, we have to be a little cautious here,’ that, you know, ‘maybe the market has gotten ahead of itself, and is now due for another pullback,'” he explains.

Since the S&P 500’s most recent high on September 2, the index has fallen over 2% (through Friday’s close). Amid the selloff in the past week, stocks closed a hair below their 50-day moving average on Friday at 4,433 points, the first day below that mark since June. And breaking the trend in back-to-back sessions could mean more red screens moving forward.

“I think it’s important in the sense that, every technical line has validity, and every time it holds, that validity gets stronger and stronger and stronger,” Randy Frederick, managing director of trading and derivatives at Charles Schwab, told Fortune. So far this year, he calculates there’s been eight times that the S&P 500 has been “close to or under” that 50-day moving average “and bounced off, and all of the sudden now we’ve broken through—that’s pretty substantial in my mind, it’s pretty significant,” he said. “I think we probably will see a few more percent downside,” he added.

Indeed, the recent rout in the markets is notable because Monday could prove the second consecutive close below the S&P 500’s 50-day moving average since November—and things aren’t looking good, with the S&P 500 down around 2.7% as of afternoon trading. Those like Frederick suggest we may “very well be looking at” a 4% to 7% pullback when all is said and done. (That’s notably shy of a correction, which is a 10% selloff or more.)

Not many ‘upside catalysts’

But what’s driving the selloff?

Some prognosticators like Stovall argue some of the jitters can be chalked up to worries about the broader market implications of the Evergrande crisis in China, where the mega property developer is in danger of defaulting on its debt this week (“I think investors are nervous, and they’re gonna want to take some profits where they can,” he said).

The 50-day moving average, meanwhile, adds its own layer of worry for more technically (and short term)-minded investors as a potential gateway to more pain in the index moving forward. Though Stovall told Fortune he doesn’t view this break in the 50-day moving average as a big shift in sentiment yet, “The real concern is whether these benchmarks will go on to test their 200-day moving averages,” he wrote in a Monday note.

Others like Frederick suggest that between Wall Street firms lowering GDP forecasts, the ongoing battle with the pandemic, questions over the debt ceiling, and the potential for higher taxes, “I don’t think there’s very many upside catalysts,” especially in the absence of positive earnings data.

Meanwhile, Friday also happened to be a quadruple witching, a day that happens once every quarter when a bunch of stock and index options and futures contracts expire at the same time. According to Frederick, who tracks options closely, there is a “huge amount” of options contracts that expire or are exercised during the quadruple witching, many of which need to be replaced. “You tend to get big, big activity, or what I call replacement activity, in the week following expiration,” he said. “The question is, are they going to be buying a lot of bullish upside positions or are they going to be putting on a lot of hedging or potential downside strategy positions? We don’t know yet, but based on today’s activity, it seems like they might be a little tentative,” suggested Frederick.

And as many on the Street have been highlighting, the market is simply overdue for a pullback. That, coupled with the historical weakness of the month of September, could be matching up with some of the moves.

The week after September OpEx (this week) is one of the worst of the year.

History is rhyming so far… https://t.co/wiYyuVv9YK
— Ryan Detrick, CMT (@RyanDetrick) September 20, 2021

So what’s the bottom line for investors?

“As you process all of this, remember that ups and downs are the nature of investing, and we’ve seen a lot of the ups recently,” Lindsey Bell, chief investment strategist for Ally Invest, wrote in a Monday note. “Even if we got a 10% decline from Friday’s close,” she added, “the S&P 500 would be 6% higher year to date. If you’re a long-term investor complaining about an expensive market, this may be your opportunity to bargain hunt.”

Indeed, Frederick notes that, “there will be probably a buying opportunity here at some point. It’s just a little too early for that, I think.”