“A segment of the market that clearly rotated out of stocks is active investment managers, per the weekly National Association of Active Investment Managers (NAAIM) survey, which asks respondents to disclose their net exposure…In fact, the one-week drop in exposure was the second largest in the history of the survey.”
-Monday Morning Outlook, September 14, 2020
In last week’s commentary, I pointed out that one segment of the market that may have helped drive stocks south in the first few days of September was active investment managers, as their exposure to equities dropped sharply from one week to the next. I commented that another group, equity option buyers, per the excerpt immediately below, were being tested, implying that if their enthusiasm for equites began to wane, the market could face another headwind.
“…equity option buyers are not buying as many calls relative to puts as they were at the end of August and into early September, as the 10-day, equity-only, put/call volume ratio remains at historical lows. But if this ratio takes out previous short-term peaks amid weak market action, you should be on guard for a sentiment shift similar to that in the NAAIM survey. The implications of such a shift would create a headwind.”
-Monday Morning Outlook, September 14, 2020
As I observed on Twitter this past Thursday, it appears that equity option buyers are now buying fewer calls and more puts than over previous weeks, pushing the 10-day, equity-only, buy (to open) put/call volume ratio to its highest level since early July. As you can see on the chart, the turn higher in the ratio is much larger than the previous instances in recent weeks, in which upturns were small and short-lived.
It remains to be seen if the shift in sentiment will be longer lasting, but bulls should be on alert that another segment of the market that helped drive stocks higher in the past few months has become less enchanted with equities and, therefore, the market is losing another source of support. This might explain why the S&P 500 Index’s (SPX) February high did not hold the pullback. Note that this index peaked at a level that corresponds with a round 10% above the 2019 close just a few weeks ago. Now, it is well within striking distance of revisiting the 3,230 area, which marked last year’s close.
In fact, last Wednesday, the 10-day, equity-only, buy (to open) put/call volume ratio hit 0.42, or 0.10 above its recent low at 0.32. The sharp move higher in the ratio from a low relative level prompted our Quantitative Analyst, Chris Prybal, to research previous instances in which this ratio turned 0.10 points higher from a relatively low reading.
As our buy (to open) volume data is limited back to 2016, we observed seven previous instances in which the ratio behaved similarly. And as the table with each instance and the summary data show, it is in these instances that bulls are most at risk of seeing a lower SPDR S&P 500 ETF Trust (SPY) in the 10 days that follow. In fact, in three of the four past instances, the SPY was lower by 1%, 4% and 16.7%.
It is usually sometime after that two-week period that the remaining bulls are flushed, setting the market up to rally by day 21 after the signal. As a side note, it is hard to overlook the last time a signal like this appeared in February, as the implications of the impact of the global pandemic wreaking havoc on world economies became clearer.
“…the CBOE Market Volatility Index (VIX--26.42) pulled back on Friday, but remains above its 252-day moving average… it remains above its 252-day moving average, implying there is enough risk in the market that you should keep the hedge you put on when the VIX topped its 252-day moving average, or you should thinking taking advantage of the VIX pullback last week to hedge your long positions.”
-Monday Morning Outlook, September 14, 2020
As an increasing number of short-term traders shift into a more cautious mode, I have been keeping an eye on the CBOE Market Volatility Index (VIX) for hints as to whether or not the last volatility pop was it, or if we have another one looming in the near future.
In the interest of keeping it simple, I think a decisive move back below the VIX’s 252-day moving average would signal that lower volatility is ahead, which would allow equities to finally stabilize after sellers emerged at the beginning of the month.
As you can see on the chart below, when the SPX made a move back above the February high early last week, the VIX did not really confirm the action and by Friday, the SPX was trading at its lowest level in nearly two months.
If more volatility is on the horizon, I see lower probability of a volatility event like we saw earlier in the year, as Large Speculators are not nearly as net short volatility futures as they were before the VIX soared into the 80 area. Election uncertainty has moved some into a long volatility trade throughout the elections, thereby reducing the size of the net short position on volatility futures.
The Nasdaq-100 Index (NDX) may give clues as to the next major move in stocks too. Friday’s break below its 50-day moving average was likely on the radar of many traders. Though I find it interesting, per the chart below, that the unpopular and sometimes important 80-day moving average acted as support at Friday’s lows. Additionally, the NDX closed just a whisper below the key 11,000-millennium level. After 11,000 acted as short-term resistance in July, the NDX moved above it in early August and experienced a close back below it on Aug. 11. The fake-out move below it came just ahead of a sharp move higher, leaving the door open for the possibility of history repeating.
Moreover, last week’s failure to move back above a trendline connecting higher lows from April to July was disappointing, but there is a glimmer of hope for large-cap tech bulls with support coming in at the 80-day moving average on Friday, and the NDX still more than 50% above this year’s closing low in March – a level that acted as support in July. Risk of more damage to the technology sector increases with closes below the 80-day moving average, and the level that corresponds with 50% above the 2020 closing low, or roughly 10,500.
Todd Salamone is Schaeffer's V.P. of Research
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