"A VIX breakout above 18.00 coincident with the SPX closing below 2,950 could set up a retest of the August lows in the 2,850 area. A worst-case scenario for bulls would be the SPX again retesting its year-over-year breakeven level, which has been the theme of many pullbacks during 2019. The October 2018 closing low was at 2,641, which came near the end of that month."
-- Monday Morning Outlook, September 30, 2019
I made the comments above on Monday morning, and at Tuesday's close the Cboe Volatility Index (VIX - 17.04) was at 18.56, and the S&P 500 Index (SPX - 2,952.01) at 2,940.25, setting in motion a decline that I anticipated. By Thursday morning, the SPX hit a low of 2,855 -- my initial target area if the VIX took out 18 and the SPX fell below 2,950 at their respective closes. The catalysts were weaker-than-expected economic data, but the August lows held, setting up a quick rally back to the 2,950 area by week's end, with market participants taking Friday morning's September employment data in stride.
"… both the SPDR Gold Shares (GLD - 140.15) exchange-traded fund (ETF) and iShares 20+ Year Treasury Bond ETF (TLT - 136.54) met a similar fate as the SPX beginning in late July after venturing into their respective 20% year-to-date zones"
-- Monday Morning Outlook, September 16, 2019
The VIX peak at the round 20 area was interesting, as not only is this a round number, but it also marks an area roughly 20% below its 2018 close. The VIX's negative-20% year-to-date (YTD) level has marked several peaks in 2019, and is not much different from an observation I made a few weeks ago about assets such as stocks, bonds, and gold – as measured by the SPX, iShares 20+ Year Treasury Bond ETF (TLT - 145.99), and SPDR Gold Shares (GLD - 141.90) – as rallies have been capped around levels that represent their respective plus-20% zones.
By Friday, the VIX was meandering around the 18 area and in between two trendlines that I have drawn connecting various highs since its early August peak in the 24 area, which is double its 2019 closing low. An "all clear" for a continued decline in volatility would be a close below the lower trendline, which is also in the vicinity of the VIX's 200-day moving average. A close above 20 would enhance the odds of volatility spike into the 24 area.
Despite the VIX pop from 14 to the 20 area over a two-week period, the weekly Commitments of Traders (CoT) report suggests that the risks of another volatility pop are still alive. Per the chart immediately below, note that historically wrong-way large speculators on VIX futures are currently at their largest short position since late April/early May. Note that in the current year, it has not been a good time to be long stocks or short volatility when large speculators are so biased toward lower volatility.
Since late April, when the SPX touched 2,950 after going pretty much straight up since the December low, the action can best be described as "messy," with a range mostly between 2,850 and 3,000. The downside below 2,950 has been greater than the upside above 2,950, but support last week came in the area of its ascending 160-day moving average again, which has been the case since the early June low.
The year-over-year (YoY) breakeven area once again held on last week's pullback, however, per the chart in my Oct. 3 tweet; note that as we move into and through the fourth quarter, the YoY comes in at steadily lower levels due to the decline that took place in most of 2018's fourth-quarter. For example, at the end of this week, the SPX's YoY breakeven level will be 2,728.37.
Coincidentally, this coming Friday, the round 10% YoY SPX return is located at the round 3,000 level, which I would pinpoint as a short-term resistance level if the SPX can get back to its 2,950 half-century mark, which has acted as resistance on multiple occasions since October 2018. In fact, 2,950 is where the fourth-quarter pullback started from.
With standard October expiration week only two weeks away, a look at SPDR S&P 500 ETF Trust (SPY - 294.35) open interest -- that includes weekly 10/11 options and the standard monthly October options (expiring Oct. 18) -- is supportive of an even tighter range between 2,950 and 3,000, as the bigger put open interest strikes are at or below the SPY 295 strike, whereas the bigger call strikes are at or above 300. Those selling the calls and puts would love to see an SPY Oct. 18 expiration close between $295 and $300, which equates to 2,950 and 3,000 on the SPX.
"On the sentiment front, one thing that has changed significantly from last week is the level of the 10-day, equity-only, buy-to-open put/call volume ratio. This ratio has declined and is now close to levels that have marked previous tops for the equity market during the past year, which I find interesting, as the SPX trades at an area at which it peaked in late July."
-- Monday Morning Outlook, September 16, 2019
On the sentiment front, it was just a few weeks ago when I cautioned that the increasing optimism among equity option buyers made stocks vulnerable in the short term. The SPX was trading at 3,007 at the time, which marked the September peak. The pullback to last week's intraday lows from the mid-September closing high was 5%. As you might expect, equity option buyers are reacting to the pullback and, as such, the 10-day, equity-only, buy-to-open put/call volume ratio is rising.
The risk to bulls, if the SPX is below 2,950, is the ratio continuing to rise since it is not yet at level that has typically marked short-term bottoms that occur when speculative pessimism is widespread. If the ratio peaks and rolls over from here, the rally would likely be minimal, as there is not as much unwinding of trader pessimism that will ultimately be supportive of stocks. A move to the top of the range would be expected, which is minimal relative to Friday's close.
Expect more of the same in the coming weeks -- "messy action" in equity benchmarks. A plethora of uncertainties has been thrown at market participants, ranging from how the Fed will deal with slowing world growth and China-U.S. trade tensions, to the instability in Hong Kong and the Middle East, a potential presidential impeachment, Brexit, and others. High-level trade talks will take place this month, with a Brexit deadline at the end. While stocks have moved nowhere on one hand, they have not experienced a major pullback amid the perceived uncertainties that were being blamed on poor economic data earlier in the week.
Finally, one chart that I found interesting that was posted on Twitter last week indicates a potential positive for the long-term equity investor. Amid growing fears of slowing economic growth, BofA-Merrill Lynch Global Investment Strategy data showed that high-yield bond spreads have not widened as they historically do amid a low Institute for Supply Management's (ISM) manufacturing index reading like we saw last week. If high-yield bond traders are correct, weaker growth assumptions being portrayed in the media could be misguided, which would result in better-than-expected earnings down the road. Stay tuned.
Todd Salamone is Schaeffer's Senior V.P. of Research.
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