"…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."
- Monday Morning Outlook, June 18, 2022
Last week's action was very encouraging for bulls. The rally in the Nasdaq 100 Index (NDX – 12,105.85) and S&P 500 Index (SPX – 3,911.74) wiped out the prior week's June standard expiration week sharp losses.
In fact, even though I mentioned ahead of June expiration week that I did not see put open interest strikes at the 385 strike and below as having a destabilizing impact on the market if breached (since most of those puts were sold to open), June expiration week's action leads me to believe that put sellers likely panicked, which, in fact, did have a huge destabilizing impact on stocks. This is because those who took the other side of the sell (to open) put sell transactions usually hedge, which in this case means going long more and more S&P futures as the out-of-the-money put strike is approached. But, if those that sold the puts to initiate the trade decide to close positions in cases where the sold put is in danger of moving in the money, long S&P futures that were put on as a hedge are unwound via selling S&P futures, therefore pressuring the market lower.
Moreover, last week's rally reminded me of March 2009, December 2018, and March 2020 in that the "V-bottom" action occurred around or after expiration week during the last month of the quarter, which are months in which option open interest tends to be higher than other months. As a result, a bigger build up in open interest potentially exacerbates short-term directional movement in the days prior to, during, and immediately following standard expiration week in those quarter-ending months.
Finally, these pivotal points in the market occurred when the Federal Reserve was involved, whether that was March 2009 and 2020, when massive stimulus was announced -- both fiscal and monetary -- or 2018, when the Fed eased back on further rate hike projections on the heels of a pending trade war with China that was creating uncertainty in the economy.
With that said, June 2022 expiration week saw a 75-basis point rate hike, followed by comments last week during Congressional testimony from Fed Chairman Jerome Powell that the Fed would stay the course until they are convinced inflation has been extinguished, even if such rate hikes put a strain on economic growth. The fact that the Fed remains hawkish (as opposed to less hawkish or flat out dovish) could put the short-term "V-bottom" at risk of becoming a more sustainable "V-bottom" like we saw following the March 2009, December 2018, and March 2020 troughs. The jury is still out though, even as the SPX and NDX moved above the first of multiple resistance levels overhead on the heels of Powell's testimony.
Specifically, the NDX moved back above 11,800, which is double its 2018 closing low. Additionally, it moved back above its 750-day moving average at 11,864, a trendline that approximates a roughly three-year moving average on the daily chart. You can see this unpopular, yet historically important moving average on the NDX chart below. Moreover, the NDX closed above the 12,000-millennium level. While there was a technical breakdown below these levels during expiration week, the fact that it occurred during expiration week and was immediately reversed is an encouraging development for bulls.
If you are brave, this move back above these key levels might suggest putting a little bit of cash into this area of the market if you are looking to scale back into equities at small intervals (implying baby steps), with the intent of unwinding such a move on a daily or weekly close back below this support area.
"…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.
- Monday Morning Outlook, June 18, 2022
The excerpt above from last week's commentary refers to the SPX's 36-month moving average, which like the NDX discussed above, approximates a three-year moving average, except on a monthly chart, using monthly closes. I included a longer-ranging version of this chart to give you additional perspective on the importance of this moving average dating back to 1990. As I said last week, it has been the site of multiple buying opportunities in the past, except in the few instances it hasn't. Be extremely cautious on moves below this long-term moving average while tiptoeing lightly into equities if the SPX is trading above and in the vicinity of this trendline, which is currently located at 3,717. With the SPX only 5% above this trendline, this does not represent a lot of risk for a longer-term market participant putting fresh money to work. Or you can confirm the rally from this moving average until it is apparent that there will be a monthly close above it on Thursday.
Additionally, per the chart below, the SPX took out its first of multiple resistance levels overhead, when it closed above the 3,800-3,850 zone that is defined by: 1) 20% below its all-time closing high, 2) 20% below the 2021 year-end close, 3) the level the SPX was trading at the close of President Biden's 2020 inauguration and 4) the extension of a trendline connecting lower highs in January and February. Additionally, it closed above 3,900, which is where the SPX closed on the Friday prior to the tumultuous gap lower the Monday morning of expiration week.
If you are scaling back into the market using the SPX as your guidepost, multiple resistance levels are still overhead, beginning with its 40-day moving average, which came into the week just above the round 4,000 level. The SPX's 40-day moving average acted in concert with short-term lows in February and March to squash the most recent rally attempt.
Some sentiment indicators that we track suggest that those short the market are vulnerable to powerful short-term rallies like we are seeing now from longer-term moving averages and oversold conditions.
For example, the most recent American Association of Individual Investors (AAII) survey showed only 18% bulls, a pessimistic extreme that has preceded rallies this year, with "optimism" in this environment as readings at or above 30%, which we saw in late March and early June.
Moreover, buy (to open) put/call volume ratios on NDX and SPX components are "off-the-chart" high, which can also precede powerful bear market rallies. But within the context of poor price over several months, such high readings are less meaningful from a longer-term perspective, at least until key resistance levels over head are taken out, bears begin feeling extraordinary pain and a sustainable unwinding of this pessimism can occur.
We have already seen three strong rallies get turned back this year, followed by new 2022 lows. This leaves me to wonder, "Is this yet another bear market rally?"
As everyone in the investing world continues to ask this same question, I saw an article in the print edition of The Wall Street Journal that made me think of the below quote from a book that is a must read for anyone incorporating contrarian analysis into their investment decisions.
"The public is right during the trends, but wrong at both ends"
- Humphrey B. Neill, The Art of Contrary Thinking
With that quote in mind, I will leave you with a headline from CNBC's web site in January 2019 when the SPX was clawing back from its December 2018 lows that were last seen in April 2017 and an except from Friday's edition of The Wall Street Journal.
The take-away for me is to proceed with caution with the Fed in aggressively hawkish mode and the public behaving in manner that is not consistent with a bottom being in place.
"Investors are hiding out in cash: Assets in money market funds surge past $3 trillion"
- CNBC, January 14, 2019
"The S&P 500 index is close to notching its worst first half in decades, yet individual investors have still purchased a net $24 billion worth of U.S. stocks over the past month, in line with the average of the past two years, according to the latest data published Wednesday by flow tracker VandaTrack. Even purchases of single equities, which are typically more susceptible to shifts in sentiment than those of exchange-traded funds, have remained robust, unlike during the Covid-19 selloff in February 2020"
- The Wall Street Journal, June 24, 2022
Todd Salamone is a Senior V.P. of Research at Schaeffer's
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