“… 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
“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.”
-Monday Morning Outlook, June 12, 2022
If you read my comments with respect to the S&P 500 Index's (SPX – 3,674.84) action around unpopular but historically significant long-term moving averages, not only in last week's commentary but in prior commentaries during the past few months, you are likely not surprised that the SPX is trading where it is now.
However, you may be surprised by the speed of the move, as last Monday's gap from the 3,900-century mark pushed the index below last month's support at 3,850, which I said would likely precede a move to the SPX's 36-month, or three-year, moving average in the 3,700 range.
As seen on the SPX's monthly chart below, pullbacks to the vicinity of this moving average have marked tremendous buying opportunities in the past, except in instances where they didn't – 2008 and briefly in 2020. As such, history would suggest that both bulls and bears should remain on high alert. If you are a bear, be cognizant of the fact that major buying opportunities have occurred in the vicinity of this long-term moving average.
For bulls, it is only the middle of the month, and I will remind you that we have found that it is best to emphasize monthly closes above key monthly moving average before you even think about committing money to the market. And even if there is a close above this trendline at month end, there are multiple resistance levels above, which should be used as certain markers before scaling back into equities, per the second chart below.
The first resistance level to watch is in the area of the S&P 500's May lows between 3,812 and 3,852 and coincides with levels that are a round 20% below the 2021 close, 20% below the all-time closing high and the close on the day President Biden took office (3,852). Even below this area, I would submit that 3,735 is a critical level to watch, which was the SPX's close the evening before the Federal reserve delivered its biggest Fed funds hike in years.
In other words, bulls should remain patient, as there is uncertainty as to whether this long-term moving average is a buying opportunity. Such uncertainty is heightened with the Fed hiking rates during a period in which last week's economic reports missed expectations, sparking additional concerns about the economy heading for a recession. Most market participants remember bottoms in the market coinciding with dovish Fed actions. But with the Fed admittedly missing the boat on how long inflationary pressures were to persist, it remains in fighting inflation mode.
Action in the CBOE Market Volatility Index (VIX – 31.13) caught my eye last week, beginning with another peak at the level that is double its 2021 close. Per the chart below, its tendency is to peak in this area amid multiple trips to this level this year. Last week was the first time a move to this level occurred during a standard expiration week, which I referenced in a tweet last Wednesday.
Notable last week were not only the top around double the 2021 close, but the convenient pullback in the front-month VIX futures contract, which the VIX will closely track as the futures contract gets set to expire. The convenient pullback from the Tuesday peak into a Wednesday morning settlement resulted in the near maximum number of VIX futures call and put open interest to expire worthless at Wednesday morning VIX futures settlement. A further decline in the VIX occurred into Wednesday afternoon, as Fed uncertainty was removed following a 75-basis point rate hike and Chairman Jerome Powell's comments following the Federal Open Market Committee (FOMC) meeting.
But note that the Wednesday afternoon low occurred at a trendline that connected lower highs in May. The VIX broke out above the trendline coincident with the Monday morning gap lower in the equity market, and the bounce from this trendline on Wednesday afternoon was the first warning of a dismal day for equities on Thursday.
Additionally, with a trendline connecting higher lows in place since late March, the breakout above the trendline connecting lower highs should be viewed cautiously by equity bulls. For those of you that remember, when the VIX broke out above a trendline in early November 2021 that connected lower highs in September and October, it signaled significantly higher volatility in the months to come.
As such, be on the lookout for another volatility surge. But first, levels such as double that 2021 close at 34.44 must be taken out.
On that note, I should address what I am seeing with respect to VIX futures option buyers. The 10-day buy (to open) call/put volume ratio is back above 2.0. As long-time followers of this commentary are aware, and per the second chart below, such readings have historically preceded volatility spikes.
In this case, the VIX call buying predominance emerged during and after the VIX spike from 24 to 35, implying for the first time in a long time, smart money VIX futures option buyers were caught off guard. To the extent many others were caught off guard by the market's action, this may be why the swift and sharp move lower in equities occurred.
But that leaves questions that, unfortunately I cannot answer, but will certainly monitor. That question is: “Does the sudden emergence of VIX call buyers mean significantly higher levels of volatility, despite the VIX near the top of this year's range? Or are the recent actions of this crowd a contrarian indicator since the call buying occurred during, versus before, a VIX spike?” Stay tuned.
Todd Salamone is a Senior V.P. of Research at Schaeffer's
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