Sentiment indicators suggest there's buying power on the sidelines
“Looking for an entry point is encouraged…Where is the entry zone, assuming Friday’s low and last week’s low around the round 4,600-century mark may not be it? If 4,600 is broken to the downside, the area between this month’s closing low at 4,513 and 4,591, the close ahead of the Dec. 7 gap, is worth focusing on. Additionally, if a retest of the SPX’s recent low is in the cards, note that this month’s closing low was also the site of the August peak, and is also the current site of the SPX’s 80-day moving average. If this month’s closing low is retested, ensure the Cboe Volatility Index (VIX — 21.57) is below 29 before entering, as this level has marked multiple highs this year.”
- Monday Morning Outlook, December 20, 2021
If you read my comments last Monday, posted ahead of the market open, those looking to buy the dip would have been fully prepared to act just hours after the commentary was posted. The S&P 500 Index (SPX — 4,725.79) entered the buy zone I discussed, and the Monday afternoon trough was around 4,530, which is the site of the unpopular but sometimes important 80-day moving average, as well as the early-September peak. In fact, a trendline connecting the late-September closing low with the early-December intraday lows came into play and provided support.
As the SPX was probing its support area, the CBOE Volatility Index (VIX — 17.96) was around the 27 area, which is below the 29 level I advised looking to for confirmation that SPX support would hold.
The September trough, for what it's worth, occurred when worries grew about a major property developer in China failing. At that time, U.S. investors were weighing major brokerages urging caution on equities, as debt ceiling worries lingered. The December low occurred just after the omicron Covid-19 variant was revealed in South Africa and Federal Reserve Chairman Jerome Powell prepared investors for a faster tapering.
“New data from Scotland and South Africa suggest people infected with the Omicron variant of coronavirus are at markedly lower risk of hospitalization than those who contracted earlier versions of the virus, promising signs that immunity as a result of vaccination or prior infection remains effective at warding off severe illness with the fast-spreading strain… The University of Edinburgh study, drawing on the health records of 5.4 million people in Scotland, found the risk of hospitalization with Covid-19 was two-thirds lower with Omicron than with Delta.”
- The Wall Street Journal, December 22, 2021
Since early December, there have been indications that the omicron variant carries less risk of hospitalization relevant to the delta variant among those that are vaccinated and/or previously had the virus. Studies late last week confirmed the early data. This has eased initial concerns about the Fed’s pivot away from an aggressive stimulus policy, amid the highly contagious variant.
With the news flow, there has now been two V-bottoms this month. But this V-bottom could have more staying power, since sentiment is more negative now than in early December by some measures, implying buying potential could be greater now than earlier this month.
Note how Friday’s close was significantly above the November closing high and the intraday highs prior to the pullback that began in mid-December.
One sign of a major “risk-off” mentality is in the 10-day buy-to-open put/call volume ratio on components of the iShares Russell 2000 ETF (IWM — 222.04). Typically viewed as risky relative to other equities — albeit a seasonally strong period for small-cap — option buyers were recently more pessimistic on these names than any other time since the Covid-19 lockdowns began in March 2020. This negative sentiment is in the early stages of unwinding, which could have bullish implications into the new year.
Admittedly weaker than other major equity exchange-traded funds year to date, the IWM found support last week around its 2021 trading range low. This year's long range is between the $205-$210 area, and the $235-$240 levels.
Other sentiment indicators we follow suggest there is buying power on the sidelines among those with a short-term horizon. The National Association of Active Investment Managers (NAAIM) reading came out last Wednesday at 67 (100 means fully invested among those surveyed).
The 67 reading suggests less exposure to equities than in early December, when the reading came in at 87, on the heels of five consecutive weekly readings above 100 that began in late-October, and ended in late-November. In other words, these managers are less exposed to stocks than early-November and early-December, even with the SPX at higher levels now relative to then.
Finally, it's time to revisit a tweet from mid-December. At the time, the SPX was rallying from its December low, but still not out of the woods.
Per the chart below, the VIX’s first close above a trendline connecting higher lows from June to September was the first hint of trouble ahead. In mid-December, not only was this trendline in play once again, but so too was a fresher trendline connecting higher lows in the previous month.
These trendlines were converging at 19 when I tweeted. After a bounce from 19 to last week’s peak at 27, the VIX as of Thursday and Friday’s close is below the trendlines I highlighted. Might this lead to a clear path to previous lows in the 15 area? If so, this would have bullish implications into the year end, and potentially January.
Todd Salamone is Schaeffer's Senior V.P. of Research
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