“A break of 4,225 support, however, would quickly put risk-reward in the bears’ favor from a technical perspective, as 4,225 would become potential resistance, with immediate downside to the 4,130 (resistance earlier this year) to 4,175, site of the important 36-month (three-year) moving average. Admittedly, there is little to almost no room for error if you are a bull, as longer-term moving averages are in sight…My concern…is that equities have not responded to the unwinding of a recent extreme in pessimism that I have observed in recent weeks.”
-Monday Morning Outlook, October 23, 2023
In last week’s commentary, I pointed out that the S&P 500 Index (SPX--4,117.37) had entered the week at potential support. In the same breath, I cautioned that there was little room for error for bulls, as it wouldn’t take much to break support and stocks were not responding, as they usually do, to an unwinding of a negative sentiment extreme among market participants just weeks earlier. The implicit concern was stocks were not rallying amid apparent tailwinds.
On Wednesday, the risk-reward was suddenly in the bears’ favor, when the SPX decisively closed below the 4,225-level, or the vicinity of its: 1) 200-day moving average, 2) the early-October lows, and 3) the level that corresponds with a round 10% above the index’s 2022 close. The SPX easily sliced through 4,206, a 50% retracement of its March 2023 low and July 2023 peak, in addition to falling below a major long-term moving averages, one of which I’ll discuss more in detail shortly.
By Friday afternoon, the SPX found itself below 4,130, which is: 1) 10% below the 2023 closing high, 2) site of a major short-term trough in February 2022, and 3) an area of resistance on multiple occasions from May 2022 through May 2023.
This should put bulls on notice.
At risk of drawing lines in the sand, the 4,100-4,115 could mark a pivot, if only in the short term. This area is the 61.8% Fibonacci retracement of the March 2023 low and July 2023 peak, in addition to an area of major sideways movement within a narrow range from early-April through late-May. Will buyers in April and May that got in before the May-July rally take a stand here?
Moreover, from a longer-term monthly chart perspective, the SPX broke below its 36-month, or three-year, moving average. As I have discussed over the years, this long-term moving average has proven to be historically important when evaluating it on a month-end close, which is timely given that Tuesday marks the end of the October calendar month.
In other words, in months where the SPX pulls back to or below its 36-month moving average but closes above this same moving average at month end, it usually marks a bullish turning point.
However, month-end closes below this moving average either precede extended declines or a short-term decline into the final low (February 2020 and September 2022 closes below marked short-term selling into the following month’s trough). The early-2001 and mid-2008 month-end closes below this moving average preceded several months of selling activity.
The SPX’s 36-month moving average had importance prior to the years displayed on the chart above. For example, a pullback to and close above its 36-month moving average in November 1971 marked a major trough. But its monthly close below it in November 1973 preceded sharp selling over the course of the following 12 months. In July 1975, it marked resistance after a six-month rally from the late 1974 low
This long-term moving average marked major lows in early-1980, late-1990, and late 1994. The 1976-1979 period is the only time going back more than 50 years that it didn’t have a lot of significance. During this time, the SPX traded in a brutal sideways trading range between $87 and $107.
Bulls would prefer that the SPX close above its 36-month moving average at 4,170 on Tuesday. If there is a close below, the hope would be that further downside is limited, with the SPX eventually troughing in November at its April and May 2023 lows in the 4,050 area.
While both scenarios are certainly a possibility, a risk is ignoring the lengthy sell signals that have occurred historically after month-end closes below the SPX’s 36-month moving average. As such, one may lighten up on equity allocation or hedge long exposure via longer-term index or exchange-traded fund put options to address such a possibility.
Be careful with respect to short-term rallies, especially if the SPX closes October below 4,170. A plethora of resistance levels reside overhead, starting between 4,130 (10% below July 2023 closing high) and 4,180, or the SPX’s short-term peaks in February and May.
The round 4,200 level could also be resistance. It is the site of the SPX’s 24-month, or two-year, moving average, which acted as resistance in February and May 2023. The cross above this moving average in June preceded a near 10% rally into the July peak. In fact, I see major resistance between 4,200 and 4,225, the latter of which was identified as potential support in previous commentaries.
This week brings a long list of earnings reports and another Federal Open Market Committee (FOMC) meeting. Per the SPX daily chart above, it hasn’t been pretty, unless you are a bear, since the last meeting on September 20. The SPX is down 7% since its close on the eve of the FOMC’s announcement when it paused and investors came to grips that rates would be higher for longer.
The Cboe Market Volatility Index (VIX-21.27) is still refusing to move above its 2022 close at 21.67, even as the SPX has declined to its lowest level since May and ahead of an FOMC meeting next week. If the VIX ultimately peaks at this level, it could be a win for bulls during this bullish seasonal period for stocks.
But note the recent “VIX support” at 19.23, which is 50% above the September closing low. At a minimum, bulls should suspect rallies that occur without a VIX move below 19.23. Even if the VIX moves below this level, be in tune with potential resistance areas overhead.
Todd Salamone is the Senior V.P. of Research at Schaeffer's Investment Research.
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