Why the SPX’s next rally could be short-lived
“A bounce in a bear market or a rally in pursuit of a bull market?… Fortunately, as market participants weighing risk and reward, we don’t necessarily need to make a bold projection, but rather to use the price action to guide us in our decision-making process…if you follow the historical scenario and apply yourself to the present, the 4,375 SPX level should be your “uncle” point to take steps to ease any bullish positions you may have initiated coinciding with the SPX breakout two weeks ago.”
– Monday Morning Outlook, March 28, 2022
The events of the past week in terms of stock price action have been unfortunate for stock market bulls. But if you’ve been following this comment over the past month, you probably weren’t shocked by what happened, or at the very least acted when the market started to crash with the shift the previous week’s S&P 500 index (SPX – 4,131.93) below 4,375.
As I said at the end of March, history has shown that vicious rallies occur in the context of bear markets and, as such, the mid-March break above a trendline connecting lower highs was uncertainty about its durability.
Granted, the SPX hasn’t officially entered a bear market by the popular measure of a 20% pullback from its peak. It has also not entered bear market mode by our measure, which is a monthly close below a long-term trend line, such as 20 or 24 month moving averages.
But the fact that the SPX hasn’t hit a new high in months, in addition to the Fed’s pivot to a more hawkish strategy to combat inflationary pressures that have lingered longer than many expected, and the SPX’s break below a long-term channel connecting higher highs and lower lows late last year certainly heightened the possibility of a prolonged period of lower stock prices as investors adjust to higher interest rates and possibly slower economic growth.
“Two charts struck me last week. The first suggests an increased risk of increased volatility and falling stock prices in the near future. VIX futures options buyers are again buying calls versus puts at a rate that has historically preceded equities’ troubles over the past year.”
– Monday Morning Outlook, April 4, 2022
“If you want to hedge against a bearish scenario with index options or exchange-traded funds (ETFs), now is the time, with the CBOE Market Volatility Index trading in line with historical volatility of 63 days (of the SPX) and about half that of this year. intraday high.”
– Monday Morning Outlook, April 11, 2022
Additionally, option buyers on CBOE Volatility Index futures (VIX – 33.40), which have a proven track record over the past few years in forecasting volatility expectations for equities, were suggesting that the volatility was heading higher, potentially jeopardizing the SPX breakout in mid-March. to be a false upward move.
These options buyers were again prescient about their timing, with the VIX hitting the 30 area as the SPX closed below the 4375 level on April 22, which was the site of the mid-March breakout in above the top rail of a channel. connecting lower bass and treble.
The close below 4,375 was followed by an immediate retest of the February and March lows in the 4,150 area, which was coincidentally the site of the SPX’s annual equilibrium level. But a rebound from this support zone did not materialize into anything substantial as sellers abruptly welcomed back to the 4,300 century mark, which had previously marked lows in October and January. In fact, the SPX closed April trading in negative territory year over year for the first time since May 2020.
Amid the carnage, the Nasdaq-100 index (NDX – 12,854.80) closed at its 2022 lows and was dragged south of the 13,000 millennium mark. Moreover, for the first time since December 2018, it experienced a monthly close lower than its 24-month moving average, which qualifies this index to be in a bear market according to our definition. It is also 22% below its November closing high, which is the consensus definition of a bear market. The Russell 2000 Index (RUT -1,864.10) also closed at 2022 lows and is trading at levels not seen since December 2020, as it is down more than 17% year over year. another and well below its 24-month moving average. .
We enter trade this week and into a new month just below the lower boundary of a volatile range since January between 4,150 and 4,600, and at the upper rail of a falling channel in play from November to mid -March. Short-term sentiment metrics and a rebound in VIX selling volume indicate that we may see more near-term upside, although the moves above the resistance levels I’m about to discuss may prove fleeting.
Bulls are wary, especially long-term bulls, that unless the SPX moves back above 4,375 in the coming weeks, rallies could be short-lived, perhaps even weaker in magnitude than bullish action from mid to late March. As such, they should be used to reduce bullish positions or to cover long positions, if you haven’t already done so.
Not only does 4,375 represent the level from which the SPX broke above a channel connecting the lower lows and lower highs from January through February, note that a new trendline connecting the lower highs from late March through mid-April developed. In mid-May, this trendline will sit at 4,375, and in early June, this trendline will sit at 4,300. As such, a move north of 4,375 can only occur if the mark of 4,300 centuries is removed, which not only turned out to be resistance this week, but could also be a formidable resistance level in a month if tested again.
Using the 20-month moving average as a demarcation between bull and bear markets, the SPX’s monthly close 14 points below this trendline officially places the index in a bear market. It’s 14% below its closing high, implying most market analysts won’t call it in a bear market, and a longer-term monthly chart would suggest it’s not in mode. bear market.
The SPX is well above its 24-month moving average at the 4,000 millennium level. As you can see, this long-term moving average has supported the SPX on several occasions. But you should also note that when the SPX breaks below its 24-month trendline, the 36-month moving average, currently located at 3,650, has come into play and/or a trendline connecting higher lows. high since the bear market bottom of 2007-2009.
As I did at the end of March, I make these observations so that you can continue to assess the risk-reward balance in the weeks to come.
While the SPX may not be in a bear market by traditional measures, I am concerned that sentiment indicators have recently behaved as if they were in a bear market. For example, during the bear markets of 2000-2003 and 2007-2009, put/call equity volume ratios tended to bottom out in the 0.50-0.55 area, down from 0.30-0 .35 during bull market phases.
Note in the chart below how the 10-day buy/buy volume ratio on the SPX components recently bottomed in an area that is more typical of a bear market than a bull market.
The extremely high level of this ratio suggests that we could be on the verge of rebounding again. But an extended period of unwinding of this growing fear will only occur if the SPX clears the resistance levels discussed.
If the SPX can’t do this, no one will be afraid of missing out on a rally and/or shorts could get bold again and use technical weakness to build short positions. According to the second chart below, this is not exactly a very short market, which implies that short coverage is unlikely to be favorable. Also, if the shorts start smelling blood, they can start building positions, and that would be a headwind.
Todd Salamone is Schaeffer’s senior vice president of research.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.