“… shorts, who have built up positions on SPX component names so far this year to the highest level since late 2020, are likely not experiencing huge pain, even amid this latest rally. One has to wonder if they will begin throwing in the towel after earnings have not so far been the market’s undoing, and debate swirls as to whether Federal Reserve Chairman Jerome Powell’s comments after last week’s rate hike represented a pivot from an aggressive inflation-fighting policy… Short-term technical bumps could reside immediately overhead, such as the June closing highs in the 4,160-4,175 region, where sellers who are looking for a second chance to de-risk may emerge. This was the area from which the SPX began a more than 10% decline in under two weeks.”
-Monday Morning Outlook, July 31, 2022
“Cleveland Fed President Loretta Mester (voting FOMC member) says inflation is not going to come down quickly; she is seeing "little signs" of progress on inflation; says she must see convincing evidence that inflation is coming down before stopping rate hikes”
-Reuters, August 2, 2022
“Saint Louis Fed President James Bullard (voting FOMC member) CNBC interview: Fed should get rates to 3.75-4.0% by the end of the year; Soft landing is possible, but Fed will need to keep hiking rates.”
-CNBC.com, August 3, 2022
“The U.S. Federal Reserve faces renewed pressure to deliver another 75 basis point interest rate hike at its upcoming meeting in September as fresh data showed job gains unexpectedly accelerating and overall employment at a record high despite soaring inflation and rising borrowing costs.”
-Reuters, August 5, 2022
“China likely fired missiles over Taiwan for the first time during its biggest military drills around the island in decades, as Beijing protested US House Speaker Nancy Pelosi’s visit to Taipei.”
-Bloomberg, August 5, 2022
Per the various excepts above, the bulls did not have a lot going for them heading into last week, from a short-term technical perspective. And market participants did not exactly have a risk-on mentality as monetary, economic, and geopolitical news emerged.
Specifically, from a technical perspective, the S&P 500 Index (SPX—4,145.19) entered last week trading just below its late-May and early-June highs that preceded a sharp decline to this year’s closing low. From a chart perspective, the thinking is that those that bought equities near the late-May and early June highs were apt to use the rally as a chance to sell and get off the trade with a breakeven if they held through the selloff and subsequent advance.
Moreover, as the week unfolded, there were macro headlines that surfaced that may have given anyone thinking about selling or shorting the market an excuse to do so. For example, various Fed governors “walked back” perceptions that the Fed pivoted to a less aggressive inflation-fighting policy at its late-July meeting. This is important, as a perception of a pivot was used as the reasoning behind the post-Fed meeting rally. And Friday’s employment number did nothing in terms of countering the comments that walked back the pivot perception.
In fact, to quantify how last week’s events impacted what the Fed might do in the months ahead, consider that at the Friday, July 29 close, Fed funds futures traders were placing an implied probability of only 17% that the Fed funds futures rate would be 350-basis points or higher as of the March 2023 Federal Open Market Committee (FOMC) meeting. The implied probability that the Fed funds rate will be 350-basis points or higher as of Friday’s close was at 78%. The target rate at present is 225-250 basis points. This data is courtesy of CME Group’s website, www.cmegroup.com.
Finally, escalating tensions between the U.S. and China over U.S. Speaker of the House Nancy Pelosi’s trip to Taiwan did not exactly embolden the bulls at these levels, especially if one was thinking back to late-2018 when trade uncertainty between the US and China was a hot topic that unnerved markets when the Fed was in tightening mode.
As you can see on the chart immediately below, yes, technical resistance at the late-May and early-June highs did exert itself. But even after technical resistance took hold and futures traders placed much higher odds on another 125-basis points of rate hikes in the next seven months, the SPX traded higher relative to the week prior’s close.
The takeaway from last week’s action could imply that market participants do not view the current path of expected rate hikes as necessarily threatening to the economy. That is, at least through the second half of this year and on the heels of Friday’s stronger-than-expected employment number.
Tough Fed talk amid weaker-than-expected data may have sparked concerns among investors and, as a by-product, more selling than what we got on Friday. Instead, and to the extent that equity option buyers are an indication, there is still an unwinding of the extreme pessimism that we saw build up into the July bottom. And such unwinding is the biggest threat to the bearish case, even with a short-term technical resistance level immediately overhead.
“If you took on a more bullish posture last week, keep risk-reward in your favor by moving one of your stop levels higher to an SPX move back below 4,000, which is where you would consider taking some money off the table. Be extra cautious if the SPX moves back below its 3,900 breakout-level. Meanwhile, there is still about 6% upside to your first target in the 4,375 area.”
-Monday Morning Outlook, July 31, 2022
The SPX did not push above short-term resistance, but seemingly negative news last week did not prevent a weekly close higher. As such, there wasn’t any reason to make any substantial moves if you took an aggressively bullish stance after the mid-July breakout above trendline resistance. I continue to think there is minimal upside to the 4,375 area for reasons discussed in prior commentaries.
Finally, I will leave you with one chart worth viewing if you are an investor in large-cap technology stocks, as measured by the Nasdaq 100 Index (NDX—13,207.69). This benchmark has rallied rather impressively off its recent lows. In fact, it has sustained a move through the 12,260 level, which was the site of what was at the time a late-May “fake-out breakout” above a trendline connecting lower highs since April.
But now it is at potential resistance from a zone of former lows in February and March, which is also a round 20% above its June closing low. Moreover, a trendline connecting lower highs since the January high is sitting just above Friday’s close. This trendline begins the week at 13,347 and ends the week at 13,261. A breakout above this trendline would cement the bullish case for this group, which is even more interesting on the heels of the May 30 cover of Bloomberg BusinessWeek magazine entitled, “The Great Tech Rout.”
From a sentiment perspective, similar to the case with SPX components, equity option buyers are in the midst of unwinding an extreme in pessimism that makes the case for a breakout above this trendline. But if you have long exposure to components of this index, it could be worth purchasing puts on the Invesco Trust Series (QQQ—321.75) to hedge the technical risk going into this week. Similarly, you could do this with SPY puts if your portfolio is not as technology oriented, with the Cboe Market Volatility Index (VIX—21.15) closing at its lowest level since April on Friday and the SPX trading just below technical resistance too.
Todd Salamone is a Senior V.P. of Research at Schaeffer's Investment Research
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