“The main event this week is the Federal Open Market Committee’s (FOMC) meeting…With the market trading aimlessly since around the time of the last rate hike, which followed a pause at the prior meeting, Wednesday’s meeting could give investors a little more clarity and at least spark more direction that what we have observed in prior weeks….Key into the SPX levels discussed … to better understand whether the needle is finally being moved in favor of the bulls or bears.
– Monday Morning Outlook, September 18, 2023
The Federal Open Market Committee (FOMC) meeting was indeed the main event last week, with its after-effect moving the needle in the direction of bears.
The new dot-plot, or charted projections of Fed governors and presidents on interest rates, gross domestic product (GDP), and the unemployment rate, revealed that anticipated rate cuts in 2024 were no longer an expectation. As such, equities sold off.
The clear hawkish stance of “rates higher for longer” was clearly not what market participants wanted to hear in the wake of inverted yield curves that could potentially be foreshadowing slowing growth or a recession, even as the economy shows resilience. Perhaps adding insult to injury was the uncertainty conveyed in Fed Chair Jerome Powell’s comments after the decision to keep rates unchanged in September.
My takeaway from his various comments is that multiple crosscurrents are making the Fed’s job challenging and therefore the central bank remains in data-dependent mode. For those not following the words of the Fed closely over the past few years, the data-dependent approach is how they operated when getting surprised by how long inflation would stick around, leading to many more rate hikes than projected at the end of 2021.
“…multiple potential support levels are just below, such as SPX 4,440, which marks the June highs and its close before a break below the bottom rail of channel since the March lows. Meanwhile, the 80-day moving average, which marked two troughs in August, sits at 4,420 with the round 4,400 century mark not far below.”
– Monday Morning Outlook, September 18, 2023
Per the chart below, the selloff was significant, as potential support levels I discussed last week were taken out, after being supportive earlier in the week before the FOMC meeting.
For example, the S&P 500 Index (SPX – 4,320.06) fell below its June high and 80-day moving average immediately following Wednesday’s afternoon press conference with Powell. And it didn’t get any better for bulls on Thursday morning, as the SPX gapped below the 4,400-century mark following Wednesday’s close just above it.
By Friday’s close, the SPX was below 4,330, which marked the June low. Therefore, an immediate risk is follow-through selling to the 4,190-4,225 area. The former is the site of the SPX’s 200-day moving average and the latter marks a round 10% above the 2022 close.
Moreover, based on continuation moves immediately following bull and bear gaps in 2023, Thursday’s gap lower suggests selling in the immediate days ahead.
Note that the SPX 4,330 level is equivalent to the SPDR S&P 500 ETF Trust (SPY – 430.42) $433 level. This is important as it relates to the SPY open interest configuration graph below for options expiring on Sept. 22 and 29. The latter are attractive for one that wants to hedge end-of-quarter weakness in equities, and therefore garner more attention than a typical weekly option.
With peak put open interest at the 430-strike (for both Sept. 22 expired and 29 soon-to-expire options), and equivalent to SPX 4,300, it is possible this put open interest acted as a magnet last week, after the put-heavy SPY 440 and 435 strikes were breached to the downside on Thursday.
In fact, the 430-strike was nearly touched on Friday afternoon before a small and unimpressive bounce from this level. It remains the largest put open interest strike for Sept. 29 expiry options that are in the immediate vicinity of the SPY, pending open interest changes this morning.
With the Sept. 29 430-strike put the last heavy (and meaningful) put open interest strike, it is possible that delta-hedging contributed to the selloff last week, but this strike could continue to act as a magnet, unless puts are liquidated before Friday.
If the put magnet effect was indeed a contributing culprit to last week’s selloff and any weakness this week, we should see the market quickly stabilize at the beginning of October, despite the move below support last week.
The sentiment backdrop supports market stability and is a risk to the short-term bear case. For example, there were more bears than bulls in the most recent American Association of Individual Investors (AAII) weekly survey – the first time since May 31 that bears were greater than bulls. And equity put buyers relative to call buyers are nearing pessimistic extremes. That said, the implications of this pessimistic sentiment backdrop are less meaningful amid a technical breakdown.
Further complicating matters is the degree to which the options market had a hand in generating the technical weakness. As I have mentioned before, when out-of-the-money heavy put open interest strikes act as a magnet as expiration nears, I put little weight in technical breakdowns as those in “must hedge” situations are generally not looking at charts.
If forced to make a call, I think the market is vulnerable to further weakness in the week ahead, but set to recovery in early October, when any remaining delta-hedge selling is exhausted (if indeed the options market contributed to last week’s selling and break of support).
Todd Salamone is the Senior V.P. of Research at Schaeffer’s Investment Research.
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