Short interest levels are mimicking three key historical periods
“I continue to see the SPX’s 4,100 level as a critical level of potential support… it is the level from which a breakout above the upper boundary of the channel occurred in April. By week’s end, the lower boundary of this channel is projected to be 4,126. Resistance at the beginning of the week is at the upper boundary of the channel, or the 4,245 area, which coincidentally is around the intraday highs earlier this month.”
-Monday Morning Outlook, May 24, 2021
Per the chart below, the S&P 500 Index (SPX--4,204.11) neither tested support or resistance levels discussed in last week’s commentary. Instead, it continued to trade within channel lines in place since mid-November, after an intraday expiration week break below earlier in the month quickly found support at its upward-sloping 50-day moving average and the level that is six times the 2009 closing low.
Throughout most of the week, however, the SPX found resistance at the 4,200 century mark, which is the same area in which bearish “tri-star” doji pattern formed in late April that strongly hinted at the early-May pullback.
As long as the SPX trades within the channel in place since mid-November that I have displayed week after week, it is a win for the bulls, as the lower and upper boundary of this channel is rising on a daily basis, implying support and resistance levels move higher daily. Moreover, even if the SPX breaks below its lower channel boundary, another area of formidable support lies between 4,050-4,100.
The lower boundary of the channel is at 4,130 to begin the holiday-shortened week, which is coincidentally the level that is exactly a round 10% above the 2020 close. At week’s end, 4,145 on the SPX will mark this lower channel line’s level. Meanwhile, a test of the upper channel would again have bulls rejoicing, as this would mark more all-time highs for the SPX.
The chart that I included in my above post on Twitter last week is option data going back to the beginning of 2018, or nearly 2-1/2 years. It caught my eye as option speculators recently reached a level of cautiousness or pessimism on components of the Nasdaq-100 index (NDX--13,686.51) going back more than a year.
Furthermore, the ratio of put buying (a bearish speculative wager or a hedge to protect a long position) to call buying (a speculative bullish bet or short position hedge) was in the upper boundary of this 2-1/2 year period before rolling over.
The roll-over in this ratio from high levels has historically been bullish, suggesting that pessimism on this group may have hit a climactic high. Therefore, odds have improved that this group could regain its leadership role after disappointing investors for most of this year.
Per the chart below, technical challenges remain for the index. First and foremost, the 14,000 millennium barrier must be overcome, which stopped the index dead in its tracks in April. Using the buy (to open) put/call volume ratio as a sign of how much sideline money can move into these stocks at present relative to April, my conclusion is that there is now more cash on the sidelines to push the index through 14,000 relative to the April period.
If a breakout occurs in the near future, I see the 14,175 area as the next resistance level above 14,000, because it is a round 10% above the 2020 NDX close.
The short-term sentiment backdrop is supportive of higher equity prices, even as the SPX trades barely below its all-time closing high of 4,232.60. In addition to the caution among option buyers, the National Association of Active Investment Managers (NAAIM) equity exposure index was at 68 last week, down from the 103 reading in late April and down from last quarter’s average reading of 83.
Additionally, only 36% of those surveyed in the American Association of Individual Investors (AAII) poll were bullish, the lowest reading since its October 28, 2020 reading of 35%.
In other words, significant cash appears to be on the sidelines among short-term traders when observing the actions of option buyers and active investment managers, plus the opinion of a small group of retail investors.
There was another number that caught me eye last week. The exchange’s released short interest information as of May 15, and total short interest on SPX components was 5.2 billion shares.
Per the table immediately below, this matches the approximate low points in total short interest in 2007, 2011 and 2012. I may not have to remind you that 2007 was the start of a bear market during the financial crisis of 2007-2009.
April 2011 and April 2012 preceded corrective periods for stocks, as displayed in the graph below the table. If there is a sentiment-based risk at present, I think the extreme low in SPX component short interest is one to have on your radar. But the other side of this argument is that in the absence of a major technical breakdown in the SPX, short interest could move below the historical lows summarized in the table. In other words, it will likely take a technical deterioration in the market before the shorts grow bold and build positions that would help generate a serious headwind in the months ahead.
Todd Salamone is Schaeffer's Senior V.P. of Research
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