“…the probability of the fed funds rate being at 5.00% or above after the March 2023 meeting rose from 58% prior to the FOMC meeting to 75% following Powell’s comments. This suggests that a number of market participants were not buying into the between-meetings talk from Fed governors, nor the impact of economic reports subsequent to the September FOMC meeting…. bulls paid a price for this change in expectations…These probabilities could change again in the days ahead, beginning with this Thursday’s consumer price index (CPI) data,”
- Monday Morning Outlook, Nov. 7, 2022
Last Thursday proved to be a mirror image of Wednesday from the week prior. Per the excerpt above, after the Federal Open Market Committee (FOMC) raised the fed funds rate another 75-basis points and heard comments from Fed Chairman Powell that suggested the end point might be higher than originally forecast just two months prior, stocks plummeted as market participants embraced a realistic probability that the current fed funds rate of 3.75%-4.00% could be 5.00% by March 2023.
However, per the table below from CMEGroup.com, following Thursday morning’s consumer price index (CPI) report that came in below expectations, market participants quickly backed off the probability of a 5.00% or higher fed funds rate by March 2023.
The eve before the CPI release, fed funds futures traders assigned a 63% probability that the fed funds rate would be at 5.00% or higher in March 2023. Hours after the CPI report, on Thursday afternoon, that probability had fallen to 30%, far below the 58% probability the eve of the Fed’s decision and Powell’s remarks that wreaked havoc on stocks and interest rates. This change in the perception of the path of future Fed rate hikes sent stocks soaring.
“Moreover, I couldn’t help but notice how SPX closes prior to Fed meetings in September last week were around the same level – 3,855 – and how, in both instances, the subsequent reactions were the same”
- Monday Morning Outlook, Nov. 7, 2022
Prior to the “CPI-driven” rally, stocks sold off sharply on Wednesday, as the outcome of the midterm elections and the new balance of power had not been determined - creating political uncertainty – in addition to renewed chaos in the crypto-currency market. This combination of events acted in concert to wipe out gains on Monday and Tuesday.
But like October, the S&P 500 Index (SPX – 3,992.93) rallied significantly after the release of the CPI data. Whereas October’s “CPI-day” rally resulted in a bullish “outside day” candle, implying a bearish immediate reaction to the data, last Thursday saw the SPX gap higher through multiple layers of potential resistance that had come into play in recent weeks that we discussed in this commentary.
“… By Friday’s close, the SPX was testing its next area of potential resistance between 3,900 and 3,942. The former represents the breakout level in July above a trendline connecting lower highs since the March peak...the 3,942 level is the site of the SPX’s break below a trendline connecting higher lows from June through mid-September…”
- Monday Morning Outlook, Oct. 31, 2022
“Following the mid-October trendline breakout and a significant peak last week, a question moving forward is: will a new trendline form connecting the August high and this month’s high?”
- Monday Morning Outlook, Nov. 7, 2022
For example, the SPX pushed above the 3,812-3,834 area, levels that coincide with 20% below last year’s close and this year’s closing high. This is also the area of its still rising 36-month (three-year) moving average, which has been touched in five of the past six months, with one monthly close below it. Major troughs over the years have occurred at this moving average. If this trendline proves to be a trough in this bear market, it will be one of the longer processes.
Additionally, the index moved above the 3,850-3,855 zone, the former being the level when President Biden took office and the latter being the closes prior to the September and early November FOMC meetings.
Finally, and perhaps most importantly, the SPX drove above 3,900, or its July breakout level, above a trendline connecting lower highs from March through June. When the index declined back below this level in mid-September, sharp selling quickly followed.
Moreover, at Thursday’s close, the SPX was above 3,942, which was the site of a break-down level below a trendline connecting higher lows from June through early September. The break below this trendline in mid-September was, in hindsight, an early warning signal that heavy selling was imminent.
With the move above short-term resistance, these levels now become multiple potential layers of support, beginning at the 3,900-century mark. The area between 3,810 and 3,855 also look like another layer of incoming support as well.
A trendline connecting the October low and this month’s low served as a launching point for the rally on Thursday. This trendline comes into the week at 3,790 and ended at 3,830, which is coincidentally the level that is 20% below this year’s closing high. This trendline could firm up support in this zone if the SPX moves below 3,900 in the days ahead.
If the rally continues, the next level of potential chart resistance for the SPX is at the 4,000-millenium level. Not only is this a big round psychological number, but it is also a 38.2-Fibonacci retracement of this year’s high and low. Just 2% above this millennium mark is the SPX’s declining 200-day moving average at 4,080, which marked peaks in April and August.
Additionally, a trendline sloping lower and connecting the major highs in 2022 - in early January, late March, and mid-August - is currently sitting at 4,116, which is not far below the important 24-month moving average, situated at 4,169. The point is that while short-term resistance levels have been taken out, longer-term resistance levels are now in clear sight after Thursday’s furious rally.
“Hedge funds that make both bullish and bearish equity wagers just unwound bets at a rate that was in line with the fastest this year, according to data compiled by JPMorgan Chase & Co.’s prime broker using a 20-day rolling window. The process, known as degrossing, also played out among Morgan Stanley’s fund clients, though the pace slowed at the start of last week. Still, at 178%, the group’s gross leverage, a rough measure of long and short positioning among clients, sat in the 6th percentile of a five-year range. Fast-money traders are finding little to get excited about in a market where the S&P 500 has been stuck in a 200-point range in recent weeks.”
- Bloomberg, Nov. 7, 2022
This sentiment backdrop favors the bulls, especially on the heels of the technical breakout last week. You have seen in previous commentaries how equity option buyers were at a pessimistic extreme going into this fourth quarter, one that is currently being unwound.
Similarly, the National Association of Active Investment Managers (NAAIM) weekly survey shows the four-week moving average of responses at 52 (zero being 100% cash or hedged to neutral and 100% being fully invested). Per the graph below, this reading is coming off an extreme low too.
And per the excerpt above, hedge funds have plenty of cash to deploy to the market.
However, “there is more work to be done” – a phrase Chairman Powell has used when referring to fighting inflation and which I will use to refer to longer-term resistance levels still lingering overhead as the Fed presses on with raising rates.
Use these various levels of support and resistance to guide you in your decision making.
Todd Salamone is a Senior V.P. of Research at Schaeffer's Investment Research
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