Large speculators on VIX futures have their smallest net short position since June 2020
“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… even if the SPX breaks below its lower channel boundary, another area of formidable support lies between 4,050-4,100.”
- Monday Morning Outlook, June 1, 2021
The S&P 500 (SPX - 4,229.89) has not rewarded bulls or bears since a tri-star doji pattern in late April, followed by a move back into a channel in place since mid-November. The only exception were the most prescient short-term timers that turned bearish at the May 7 close, and bullish at the May 12 and/or May 19 closes.
The benchmark’s price action since mid-April is best described as sloppy, with a series of short-term peaks and valleys, and a couple periods of sideways action. There have also been story lines, with sector rotation being one of them, as well as a rather impressive resurgence of “meme stocks” such as AMC Entertainment (AMC), Blackberry (BB), Gamestop (GME), and Bed, Bath & Beyond (BBBY), all of which are highly shorted. Plus, trading opportunities for those focused on individual stocks and/or sectors have been plentiful, amid the chaotic broader-market action.
Since May 13, all SPX closes have been contained inside the channel I have included in this commentary. This might be considered a win for the bulls, though, as I described last week. With that being said, the bottom of this channel as we enter this week’s trading is at 4,148, with the upward-sloping 50-day moving average currently sitting at 4,138. At the end of the week, the bottom boundary of the channel is at 4,166.
The upward boundary of the channel – or the higher levels of potential resistance with the passage of time -- is at 4,283, with Friday’s upper boundary at the round 4,300 century mark. However, note that the SPX failed to take out this year’s early May closing high of 4,233 last week, which is another level to tune into.
“The Federal Reserve will soon begin selling off the corporate bonds and exchange-traded funds it amassed last year through an emergency-lending vehicle set up to contain the Covid-19 pandemic’s economic fallout. The vehicle, known as the Secondary Market Corporate Credit Facility, or SMCCF, held $5.21 billion of bonds from companies including Whirlpool, Walmart and Visa as of April 30. In addition, it held $8.56 billion of exchange-traded funds that hold corporate debt, such as the Vanguard Short-Term Corporate Bond ETF.”
- The Wall Street Journal, June 2, 2021
The SPX’s price action can be interpreted as resilient in the context of the news flow. In other words, the Fed has hinted that it is almost time to talk about tapering mortgage and treasury bond purchases. Such talks were followed by a statement on Wednesday that the Fed will begin to gradually sell off the corporate bonds and exchange-traded funds (ETF) it began acquiring last year, in an effort to shore up credit markets amid the Covid-19 pandemic.
While the stock market has lost some steam amid the Fed headlines, it might be discouraging to bears that it has not aggressively declined in response to those statements. In fact, the SPX comes into this week just three points below its early May, all-time closing high. This is important, as some bears blame the Fed for manipulating stocks higher with its easy-money policy and aggressive actions last year to ensure the viability of credit markets. Even the specific equities and ETF mentioned in the Wall Street Journal excerpt above took last week’s news in stride.
Discussions about SPX component short interest being at extremely low levels that preceded a 2007 bear market, as well as notable corrections in 2011 and 2012, are still worth keeping on your radar as the Fed moves on to being less supportive. If market participants decide the economy cannot thrive amid a less supportive Fed, you will see the SPX’s technical backdrop deteriorate. As it stands, a reopening economy amid vaccine rollouts in the U.S. and abroad seems to be more significant than the Fed’s tapering talks.
On the volatility front, a couple of graphs could be hinting at lower volatility in the weeks ahead. The Cboe Volatility Index (VIX - 16.42) retreated below its 2021 half closing high at 18.60, after popping above it on Thursday morning. It wasn’t long after I tweeted the comment above that the SPX rallied for the rest of the day and through Friday. Per the chart below, the 18.60 area acted as resistance last week, which is the first step to achieving a new low in 2021. In order to reach that low, it must move below 15.38.
The following chart gives me reason to believe lower volatility and higher equity prices are on the immediate horizon. Note on the graph below that large speculators on VIX futures have their smallest net short position since June 2020.
This group of traders is usually short the VIX futures market, so I look at the net short position relative to the historical past. As the positioning of this group is usually extremely wrong, one can make the case for lower volatility expectations in the near term.
In other words, the VIX has moved higher when this group has had an abnormally large short position on VIX futures. But when they move into a rare net long position, or an unusually small net short position, lower volatility tends to follow. In fact, note on the graph below that the VIX declined in June through August last year, amid a small net short position on VIX futures at the beginning of the decline.
Lower volatility and higher stock prices might surprise seasonality traders with the “sell in May and go away” mentality.
Todd Salamone is Schaeffer's Senior V.P. of Research
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