The path is clearing for continued SPX upside
“Monday morning's action was suggesting that a ‘head and shoulder’ topping pattern was in place, but that was not the case at the close of that day’s trading (which is why we emphasize closes). Bulls can take some comfort in the fact that … a bullish inverse ‘head and shoulder’ breakout in September led to strong gains. But a brief bearish ‘head and shoulder’ breakdown early last week only lasted a couple hours before the neckline was retaken…Bulls successfully defended the close ahead of the pre-election results and a ‘V’ rally commenced the rest of the week”
- Monday Morning Outlook, January 21, 2025
President Donald Trump took his presidential oath for a second time last week, with the stock market closed on Monday for Martin Luther King Jr. Day.
In Trump’s first week in office, he urged the Organization of the Petroleum Exporting Countries (OPEC) to lower oil prices, did not slap tariffs on China, and called on the Federal Open Market Committee (FOMC) to lower interest rates. Market participants were receptive, bidding the S&P 500 Index (SPX — 6,101.24) higher last week.
Since avoiding a selloff two weeks ago related to a potential expiration week, with a delta-hedge selloff and a bearish technical pattern nearly signaling, the SPX has rallied significantly. After the SPX troughed at its Election Day close around 5,780 on Jan. 13, it surged nearly 6% to this past Thursday’s all-time closing high.
“The S&P 500’s recent leg higher has been missing an important ingredient: inflows from big-money managers... institutional investors reduced their bullish wagers amid uncertainty about President Donald Trump’s policies and the Federal Reserve’s interest-rate path. A measure of aggregate positioning among rules-based and discretionary investors fell to a two-month low, according to Deutsche Bank AG’s data. And commodity trading advisors cut their long stock exposure to the level last seen in the aftermath of a market rout in August, data compiled by Goldman Sachs Group Inc.’s trading desk show.”
- Bloomberg, January 23, 2025
Last week’s new high took some by surprise. But keep in mind that professional investors were not anywhere near extremes in bearish positioning that might precede a long, sharp rally. For example, the chart below appeared in Bloomberg article excerpted above. It reveals that professional traders reduced positions from a bullish extreme that signaled trouble ahead, but this group was still net bullish, albeit less bullish, and far from being at a bearish extreme.
Source: Goldman Sachs
A group that might have been shocked by the rally last week is short-term SPDR S&P 500 ETF Trust (SPY — 607.97) options traders, as noted by the extreme bias toward put adds relative to call adds in the five days preceding the Jan. 24 expiry.
“…short interest on SPX component stocks increased nearly 5% in the first half of December and is now at the highest level since 2018. Even with the SPX up about 25% this year, short interest on component stocks is up nearly 20%. This means this year’s theme of a highly shorted market will continue into 2025. Whereas the market rallied amid a build in short interest in 2024, might we see short covering in 2025 pave the way for the bull market to continue? Stay tuned.”
-Monday Morning Outlook, December 30, 2024
As we approach the heart of earnings season, I doubt buyback activity played a significant role in the rally, as companies are not supposed to partake in such activity in the weeks preceding earnings. But a theme that was in play last year and is still very much a theme this year is the fact that this is a highly shorted market at new all-time highs.
The implication is declines could be modest as shorts look for a place to cover, and losing positions or margin calls may occur during a rally. Short interest figures as of mid-January will come out this week, but it may be the end-of-month data that gives us a better clue as to whether short covering helped support a rally since mid-January.
Turning to the charts, the first piece of good news for the bulls is since the bearish “outside day” candle on Dec. 18 that signaled short-term trouble ahead -- as such candles did throughout 2024 -- the SPX is now above the high of that bearish candle day. Moreover, the index did not experience a bearish “outside day” candle at all last week.
Multiple potential support levels are below, starting with the December high at 6,100 and the mid-November and early-January highs at 6,020 that were the potential shoulders of a bearish “head and shoulder” pattern that was never completed. Right below 6,020 is 5,997, which marks the close ahead of Inauguration Day last week. Just below 5,997 is 5,964, site of the trendline connecting lower highs prior to the breakout above this trendline on Jan. 17.
With multiple potential short-term support levels below, the lowest being 2% below Friday’s close, the path is clear on the upside, with another all-time closing high on Thursday. But there are a couple levels overhead to keep on your radar that could be hesitation or pivot points.
The first level to be aware of is 6,138, which is exactly 20% above the early-August low. Those in profit-taking mode and anchored to the August low may reduce long positions or hedge in this area, both of which can be headwinds.
The second level is one that you heard about in this commentary during the fourth quarter of last year. It is SPX 6,215, the target for the bullish “inverse head and shoulder” breakout in September. I was looking for this target to hit by year-end, but better late than never.
Todd Salamone is Schaeffer's Senior V.P. of Research
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