“… if you make a commitment to equities, you may want to consider easing back in, as there is still major potential resistance from 4,170, the March closing low, and 4,375 above. How the market behaves around these levels, if tested, may further clue us in as to whether this is a short-term rally in a bear market or a longer-term rally. For example, if the SPX fails to take both these levels out and subsequently moves back below its 24-month moving average, the odds increase that the recent lows will be violated. But a move above these resistance levels would enhance odds that a longer-term rally is on the horizon.”
- Monday Morning Outlook, May 29, 2022
“While longer-term charts look encouraging for bulls, this is far from meaning that the 'all-clear' sign is flashing…a monthly candlestick graph of the SPX with its 24-month moving average is encouraging for bulls, as there is a lot of history on their side. But with the Fed hiking rates and an unclear path as to how far it will go to fight inflation, the jury is out as to whether several resistance levels overhead will prove impenetrable. If you remain patient about committing more dollars and use SPX price action to guide you, you will have little at risk if sellers emerge in these resistance areas that I have been pointing out to you…”
- Monday Morning Outlook, June 5, 2022
The observations and guidance discussed in this weekly commentary served as useful guidance, based on the selloff in equities late last week. The S&P 500 Index (SPX – 3,900.86), after trading in a two-week range just below potential resistance from the June 2021 and March 2022 bottoms, made a decisive move below its range lows. If there is any silver lining, it was that that Friday's close at 3,900.86 was just above last month's closing low at 3,900.79. However, the fact that the SPX closed at its low of the day on Friday implies sellers are still in control going into this week, at least into Monday morning.
Moreover, the SPX moved back below its 24-month moving average at 4,071, implying that if you have not yet tiptoed back into the water, you should refrain from doing so at this juncture.
If you did tiptoe back into equites, you were likely underweight, with little damage to your portfolio. While I am sure you don't have to be told this, I'll simply remind you that managing risk is of utmost importance in this environment, given the sketchy technical backdrop.
You can manage risk by underweighting equities, or ensuring a hedge is in place using index or exchange-traded fund options.
With that said, bulls clearly would have preferred action like June 2019 or October 2020 -- months in which the SPX pulled back to and closed above its 24-month moving average. In those instances, the index rallied in the months following, without a revisit of this long-term moving average. The situation at present adds a layer of complexity in assessing risk since the SPX is trading back below the 24-month moving average after May's monthly close above it. A close below 3,850 would likely result in a move down to the SPX's 36-month moving average in the 3,700 range. This is a trendline that has marked multiple monthly closing troughs in the past, with notable exceptions in June 2008 and March 2020. The monthly close below the trendline in March 2020 was followed by limited selling in the month after, while the June 2008 hinted at big troubles ahead for the next several months.
The SPX chart above clearly establishes resistance and support levels from various highs and lows or trendlines connecting lower highs.
Additionally, the upcoming week brings standard June expiration week and the added bonus of a Federal Open Market Committee (FOMC) meeting on Wednesday. As of Friday, according to the CME's FedWatch Tool page, Fed funds futures speculators are assigning a 76% probability of a 50-basis point hike and a 23% percent probability of a 75-basis point hike. On June 9, the day before Friday's CPI reading, they assigned a 3.6% probability of a 75-basis point hike.
The below graph of the SPDR S&P 500 ETF Trust's (SPY – 389.80) June open interest configuration may give us a hint of what expiration week could bring.
At first glance, with the SPY coming into the week far below the put-heavy 400 strike and trading right around the put-heavy 390 strike, plus heavy put open interest stacked mostly in five-strike increments all the way down to the 330- strike, it looks downright scary.
If the put open interest at each strike was made up of buy (to open) activity, there would be a serious risk of delta-hedge selling throughout the week, as those selling the puts are forced to hedge by selling more and more S&P futures on additionally SPY weakness. In other words, it would create a potential snowball effect, as selling begets more selling as expiration nears and the next put heavy strike comes into view.
However, after digging deeper into the make-up of the put open interest at various strikes, I found that the 385 strike, and heavy put strikes below it, are made up of a balance of buy (to open) and sell (to open) activity. As such, I don't see the 385 strike and other put-heavy strikes below it as having a destabilizing impact on the market like the 390 and 400 strikes, where most of the put open interest was buy (to open) generated. Additionally, for what it is worth, the 385 strike is coincident with SPX's 3,850 level, or the May intraday low.
As such, a further move below the SPY 390-strike may spark more selling due to delta hedging activity, and this could happen as early as Monday morning. But other major put open interest strikes below should not have such destabilizing consequences. Other factors outside the options market could inspire additional sellers to emerge, such as a break of the May intraday lows or the “known, unknown” with respect to the Fed meeting.
Todd Salamone is a Senior V.P. of Research at Schaeffer's
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