“While the VIX experienced a notable pop towards the end of last week, its 252-day moving average -- which equates to roughly one year -- acted as resistance in Thursday’s and Friday’s sessions. This moving average marked short-term VIX peaks in December 2019, January 2020, December 2020 and January 2021…If the VIX closes above this trendline, which is situated at 30.50, the risk of further damage to equities increases in the short term.”
- Monday Morning Outlook, March 1, 2021
The jury is still out as to whether the Cboe Volatility Index’s (VIX -- 24.66) late-January pop above its 252-day moving average is a warning shot to investors, but it is clear that they are undoubtedly being tested -- as we saw again last week.
I observed in a recent commentary that since February 2020 -- when the VIX moves above this trendline for the second time in a short period, as it did in February and October 2020 (circled in the graph below) -- the VIX subsequently moved above its prior high. Therefore, after the VIX moved above its 252-day moving average in late-January and quickly retreated back below, a move back above this trendline would likely mean a VIX reading above 37 in the near future.
But, for the second time in as many weeks, the Thursday and Friday VIX peaks failed to take out its 252-day moving average, suggesting that as we enter this week's trading, the bulls remain in control. In fact, this long-term moving average (which equates to the VIX’s average for one year) has marked peaks in VIX spikes four of the last five times since mid-December.
For now, the script is that if you are using the VIX for clues on equity direction, be cautious when this volatility expectation measure retreats to the 20 area, as it did in early December and mid-February. Moreover, look to be buyers when the VIX rallies up to its 252-day moving average and shows evidence of retreating. But buyers beware -- if the VIX closes above the 252-day moving average again, prepare for more short-term equity damage.
“I found the huge short covering in the second half of January on SPX components interesting… Short interest on SPX components remains a little bit above the 10-year and 15-year lows that preceded market weakness.”
- Monday Morning Outlook, Feb. 16, 2021
As equities have been generally strong from a technical perspective, I have been making noise for weeks surrounding the sentiment-based risk with respect to the extreme optimism among option buyers -- even on small-cap components as of the end of February -- and total short interest on S&P 500 Index (SPX -- 3,841.94) components being at multi-year lows.
Therefore, it may not be a huge surprise to some of you that since the mid-February closing highs on the SPX, Russell 2000 Index (RUT -- 2,192.21) and Nasdaq 100 Index (NDX -- 12,668.51), which occurred around the time that the VIX was trading at its six-month floor in the 20 area, these indices were down 4.2%, 6.6%, and 9.7%, respectively, as of Thursday’s close.
Per my Friday morning observation on Twitter, I rhetorically asked after the close below the SPX’s 50-day moving average if weaker hands would get flushed out at the wrong time. In my opinion, this was a legitimate question, since levels that are not focused on by the masses proved supportive at the intraday lows in that session’s trading.
For example, the 80-day moving average, which was situated at the 2020 closing level in the 3,750 area, marked the lows. Historically, this moving average has proven to be a significant pivot point from time to time, as I alluded to in my observation.
So, while buyers emerged at familiar support levels to us, it remains to be seen if the SPX can climb back into the channel that it was trading in since mid-November. The bottom of that channel ranges between 3,865 at the beginning of this week’s trading, to 3,885 by week’s end. For what it is worth (not shown on chart below), a trendline connecting lower highs since mid-February ranges between 3,895 to start the week and 3,885 on Friday.
While the RUT’s decline trough Thursday’s close was bigger than that of the SPX, it found support in familiar territory, as the level that is 10% above last year’s close acted as support again. We have mentioned this level in the past, as it acted as resistance in late-January. Coincidentally, this level also corresponded with the index’s 50-day moving average.
I continue to prefer small caps over mega-cap and large-cap stocks due to the short-covering potential. But I would not be surprised that if support continues to hold, the index will still have trouble overtaking its previous high in the near-term, as option buyers suddenly hit an optimistic extreme coming into March (second chart below).
If support breaks, I think the 2,000 level could eventually be in the cards, as the index got through this millennium level after only a brief hesitation in December -- a seasonally strong period for these stocks.
The NDX took the biggest punch, with a near 10% correction from the February high through Thursday’s close. In fact, in early December, I began cautioning about sentiment-based risk related to over-zealous option buyers, but the index grinded higher. And in early January, the ratio of put buying to call buying on NDX components hit a multi-year low.
I find it interesting that the lows last week occurred around the early-December levels (circled in the graph below). This implies that those last to arrive at the party in early December and early January -- when those cautionary comments were made -- have been rewarded very little, or may be facing losses. In other words, a price was to be paid, though it came later than I expected.
The NDX did hold at a level that corresponds to a round 10% below the February closing high, which coincided with its 120-day, or six-month moving average. I found this moving average interesting not only because it acted as support last week, but also because around six months ago, or September 2020, option buyers on NDX components hit an optimistic extreme, per the graph below. In other words, this moving average may indicate that latecomers bought into large-cap technology names. Such investors could have weak hands and aggressively sell if they begin losing money.
The good news is that this ratio is now hitting levels that represented a bottom on a prior pullback. But the risk is that if the unwinding of this extreme in optimism continues --which it could based on historical highs in the ratio -- big-cap technology stocks could undergo further selling pressure. It is probably best to key to last week’s NDX lows for clues as to whether or not the unwind in enthusiasm has more to go, or a tradable bottom is in the cards.
Todd Salamone is Schaeffer's Senior V.P. of Research
Continue reading: