“The area between SPX 3,812 and 3,850 has not exactly been an area at which major pivots have occurred in 2022, but it has been a zone at which the SPX has ‘chopped around’ for brief periods this year, as we experienced in June-July and late-October into mid-November… from both a technical perspective and an option-related perspective, the 3,800-3,812 area becomes an important lower support area in the week ahead for bulls.”
- Monday Morning Outlook, December 27, 2022
The first week of trading in 2023 performed the same as we have experienced since mid-December (barring Friday). In other words, from Monday through Thursday, the S&P 500 Index (SPX – 3,895.08) found itself trading in a narrow range, defined for the most part by 3,850 as its upper boundary, and the 3,800-3,812 zone as its lower boundary.
These levels are significant, with 3,850 a half-century mark and the approximate close when U.S. President Joe Biden took office in 2021. Plus, the 3,812 level is a round 20% below the 2021 close, and only a few points above the 3,800 round century mark.
Prior to Friday’s bullish reaction to the December employment report, the SPX had closed at or between these levels on 11 of the previous 13 trading days, with multiple trading days in that period testing both the upper and lower boundaries of the range on the same day.
“As we enter 2023, bulls and bears are at risk as to how the current range ultimately resolves itself. Does it represent a pivot area from which stocks reverse the sharp selling that occurred after the FOMC meeting earlier this month? Or is it simply a hesitation zone before the selling resumes?.”
- Monday Morning Outlook, January 3, 2022
As I indicated above, Friday’s action potentially moved the SPX out of its narrow range, at least for the time being. While the rally is encouraging, as is the case when the market tries to dig its way out of a bear market, there will always be a multitude of potential resistance levels to overcome.
Our readers are very familiar with the importance I have assigned to the 3,900-century mark, the site of the July breakout above a trendline connecting lower highs from March through June, and then a support level in September and resistance level in November.
On Friday, the SPX’s highs were in this area, implying we enter the week at a potential resistance point. Even if 3,900 is taken out, the area between 3,920 and 3,940 resides just overhead. The latter is the site of a breakdown below a trendline connecting higher lows from mid-June to early-September, with the breakdown occurring in mid-September. Meanwhile, 3,920 is the site of the SPX 30-day moving average, which is sloping lower and marked resistance in mid-September, and support in early November.
“... even if the SPX recovers from this monthly close below the 36-month moving average, remember the trendline that has connected all major lower highs in 2022 as being a point of long-term resistance. The trendline comes into the new year at 4,009 and will be at 3,940 at the end of this month”.”
- Monday Morning Outlook, January 3, 2022
The SPX did close above its 36-month moving average to begin 2023, a trendline it has touched for six consecutive months and from which many bear market troughs have occurred.
But the trendline that has connected significant highs since the January 2022 peak comes into the week at 3,996 and ends the week at 3,983, with the close prior to the December Federal Open Market Committee (FOMC) meeting in between these levels.
The first area of support, meanwhile, continues to be the 3,800-3,812 area. A breakout above the trendline connecting significant highs since the January 2022 peak would complete a bullish inverse “head and shoulder” pattern that might be developing, using the June low as the left shoulder, the October low as the head, and the December lows as the right shoulder.
A breakout above this trendline could lead to a 10% to 12% rally after the breakout. This might suggest putting a little money to work, assuming the SPX remains above 3,800 and Friday’s move above the three-week range has staying power.
While there is a multitude of potential resistance levels immediately above that are discouraging for bulls if their sole focus is on the charts, another encouraging factor to consider is the short-term bearishness among traders that has built up since the December high, and the narrow range that followed the bulk of mid-December, after FOMC selling.
Note in the chart below that the 10-day, buy-to-open put/call volume ratio on SPX components surged above the March 2020 level during the current range. This implies that an unwinding of this negativity is more than enough to push the SPX above the various resistance levels discussed above.
While the direction of this ratio is not on bulls’ side, one might anticipate that this ratio could roll over if the SPX moves above the 3,900 level. And as you can see on the chart below, rollovers in this ratio are usually a good time to be long -- at least in the short term.
I think longer-term bulls would like to see not only a rollover in this ratio, but a low in the ratio that gets below the prior low (in this case, 0.75), as the ratio itself has made a series of higher highs and higher lows since December 2020.
“Insider sentiment, measured by the trailing three-month average ratio of companies whose executives or directors have been buying stock versus selling, has dropped for six consecutive months… That is the longest such decline in almost two years…Insiders typically have greater insight on the business outlook, and the fact that they haven’t been scooping up their own stocks as the market tumbles suggests they believe that it might not have bottomed just yet..”
- The Wall Street Journal, January 5, 2023
Turning to sentiment from a longer-term perspective, the consensus is expecting recession, albeit a mild one. At the same time, bond investors seem to be at odds with the Federal Reserve, as they expect a rate cut this year. One might argue there is some apprehension as it relates to the economy and its impact on earnings, as is evident by the behavior of insiders, or public company executives. Yet there is hope that the Fed will cut rates in a recessionary period.
Stagflation might be the biggest risk we face in 2023. If the economy slows or even contracts amid the inflation that the Fed continues to fight, bond investors could be disappointed. After all, the Fed’s mandate is fighting inflation, not managing gross domestic product (GDP) growth.
Todd Salamone is the Senior V.P. of Research at Schaeffer's Investment Research.
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