Reiterating several key trendlines investors should be aware of
This has been one of the worst starts to the first half of the year for equities, with the S&P 500 Index (SPX – 3,825.33) currently down 19.7% year-to-date. Only a dozen years pale in comparison when looking back at history for analogies to our current trajectory. In fact, 1932, 1940, and 1970 are the only recorded years that were worse off at the end of the first half of the year.
However, the good news is that we typically see some sort of a relief rally for equities when this happens in the month of July, as the strong seasonal month attempts to brush off negativity. The bad news is, most of the years where equities were down 10% or more at the end of the first half, continued to struggle after their mid-summer rallies. The only exceptions were 1970 and 1982, as equities miraculously finished positive those years. Moreover, history shows a potential relief rally could end as early as August or extend into the fall before stalling out. This leaves us to remain in a nimble and agile trading regime as we weather through one of the toughest trading environments since 2008.
“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.”
- Monday Morning Outlook, June 26, 2022
Last week, the S&P 500 closed back below the key 3,852 level (representative of the S&P 500 closing price marking President Biden's 2020 inauguration) following a temporary move above here the week prior. Similarly, this level happens to rest near 20% below the 2021 year-end close as we've mentioned in past commentaries. These psychological levels have become a near-term critical zone over the last three weeks, coinciding with the gap down level on June 13 acting as the major pivot point. A move back above 3,850 in the SPX, at the very least, could drive a small rally to test the 40-day moving average, currently at the 3,948. This is where price action was capped multiple times in the early June bear rally. If price action can breach the 40-day moving average this time around, I'd expect a move back toward the upper rail of its current down trend that could push the SPX to the round 4,000-millennium level.
Yet, if bears remain in control this week, a technical break 3,750 would be the first level I would watch for further downside, as these traders attempt to shrug off the seasonally bullish month of July. This would open the door for equities to potentially continue lower for the first few weeks of this month. If bears can sustain the downside momentum and break through recent lows at 3,640, we could experience a swift move to test the 3,550 to 3,505 support zone. This level coincides with the 50% Fibonacci retracement level from the March 2020 low to the January 2022 high, and the September and October 2020 highs, making it a logical downside target.
Furthermore, the open interest configuration for the S&P 500 Trust ETF (SPY – 381.24) aligns well with both technical possibilities outlined above. July's monthly expiration 370-strike peak put level sticks out like a California Redwood. These contracts are predominantly sold-to-open by market makers, and such could be indicative of solid support. Still, a breach of this level and the subsequent technical lows I indicated above would potentially put us in a delta hedge scenario that would bring us to the 350-strike, which matches our bearish technical target.
However, the Nasdaq 100 (NDX – 11,585.68) and the Russell 2000 Index (RUT – 1,727.76) also sit near areas where it is logical to think a bear market rally could happen. The NDX closed just above the 40-month moving average in June, which has been an area where monthly candlestick wicks have seen support in the past, and Friday's price action was able to hold near this level for the time being. Interestingly, the Nasdaq hasn't lost this level since regaining it in November 2009. Even during the 2000 tech bubble, the 40-month moving average served as support for a massive one-month bear rally before resuming its downtrend. Furthermore, the RUT is trying to find support at its 2020 highs. These developments force us to consider adding some long exposure, even if it's just for a short-term trade.
When looking at one of our favorite sentiment indicators, the 10-day buy-to-open put/call volume ratio for the S&P 500 components came in with a reading of 0.76. This paints a backdrop where we can see a short-term rally, but within that context, being able to call any kind of meaningful longer-term bottom remains murky, as these levels remain below prior peaks when compared to broad market pullbacks during major recessions. However, the ratio is still rolling over from an extreme peak level that we saw in May and June. Concurrently, the NDX's 10-day buy-to-open put/call volume ratio is also falling, with a reading of 0.81, and is one-week removed from highs not seen since 2016. Furthermore, that high was a stone's throw away from the peaks we saw in 2012 and 2016.
Bulls and bears find themselves in spots where they need to manage expectations and wait for confirmation on the direction. As a trader, these are the times where we often can get ourselves into trouble being biased or even simply getting whipsawed as market participants duel for direction. Stay nimble but be patient at levels like the ones we've mentioned before. A move above 3,850 and we can consider going long for a trade, as we highlighted earlier the areas to watch and target. A failure here and we could be in for a wild couple of weeks into the July options expiration. At these points in bear markets, it is less about forecasting direction and more about execution because you don't want to get caught on the wrong side of the tape.
Matthew Timpane is a Senior Market Strategist at Schaeffer's Investment Research
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