It’s been a while since we last spoke… In fact, it was all the way back when I warned of a post-September 2023 options expiration swoon that could create opportunities for bulls to buy the dip into mid-October. But even I didn’t think equities would go on such a historic run, up +25.51% from the October lows. That’s the thing about trend following, though; we trade the trend until it ends.
In recent weeks, we’ve recommended not fighting the momentum, and to be honest? Not much has changed in the short-run. We continue to see dips to the 10-or 20-day moving averages on the S&P 500 Index (SPX – 5,123.69) get bought up as we ride the upper rail of the price channel.
However, we did print a spinning top candle on the weekly timeframe last week, which typically denotes indecision amongst traders. This was on top of a nasty close on the daily chart, where we had an outside reversal candle. This tells me traders are getting nervous about a pullback. Moreover, this comes at the top of a trendline connecting the 2000 and 2021 tops. So, some long-term obstacles are starting to pile up that could stifle the bull run.
This all comes on the heels of Federal Reserve Chairman Jerome Powell’s testimony before Congress, reiterating what he has been saying for months. To paraphrase, Powell expects interest rates to have peaked for the cycle, and foresees rate cuts this year, but the committee is in no rush. The CME target rate probabilities forecast no change for March at a 96% probability. And a cut in May has fallen to just 23.22% from 52.19% one month ago.
The bet appears to be that the Fed has pushed the cut to June, a probability that has increased from 41.85% to 57.44% over the last month. I hesitate to believe one month makes the difference, and I think if the Fed doesn’t cut in May, they will wait until the second half of the year. Still, even with Powell downplaying when rate cuts will happen, the U.S. Dollar and the 10-year Treasury continued their longer-term downtrend below significant resistance levels.
“For example, the VIX did not come close to moving above 14.71, a level that could hint at trouble ahead if taken out to the upside. That said, the VIX is sitting at trendline support using a series of higher lows since December 2023..
-Monday Morning Outlook, March 4, 2024
The Cboe Volatility Index (VIX – 14.74) once again popped and faded from one-half of the 52-week high level that has been capping volatility. However, it did manage to close near the 14.71 level mentioned last week, but still below 15, which the VIX has keyed off as a pivot level since 2021. A closing candle above 15 would signal caution, however it should be noted the last couple of breaks above were quickly negated in the following two days, so maybe a better level to watch is 16 for confirmation.
Something I like to follow is the SPX:VIX 10-day and 63-day correlations. I have alerts set for any reading above 0.00, because moves tend to happen when the SPX and the VIX gain a positive correlation. Sometimes, it’s simply a pullback before another rally. Other times, it marks a major top, and more rarely a market low.
It’s not perfect and sometimes has a slight lag, but it’s a decent indicator to alert of impending moves in equities. The correlation has recently pushed to a 20-year high. Remember, volatility can act in both ways, which is one reason we have continued to melt up. So, while you need to hold on as long as the trend remains intact, this tells me adding new long-term positions is not optimal, and we could see a better opportunity in the near future.
This week is also a large quarterly expiration. These often can present turning points in the market, so let’s review the open interest configuration for March standard options expiration (OPEX). The S&P 500 SPDR ETF (SPY – 511.72) is currently above the 510-strike call level, so if equities want to continue to push higher into OPEX, look for strikes at 515 and 520 as areas where price could be capped for the week.
However, if price breaks below the 510 level, it wouldn’t take much to push the market back to the lower trendline, setting up a break of the rail and the 20-day moving average to test the round 500 level, which is the spot of the first large put open interest area. Below that, we have a significant build-up of put open interest at the 495-strike, which will likely be defended fiercely if the price happens to get there, as it also fills the open gap from Feb. 22.
Post-expiration configuration through April shows call strikes at 515 and 525 as areas of potential resistance, and we also have a stacked put configuration starting at the 500-strike and all the way down to the 460-strike, which is -10% lower from Friday’s close. Trading back to the 460-strike certainly wouldn’t be my base case; more like a worst-case scenario.
Momentum has been too strong, and we have many layers of support below to think the market will have a significant selloff, especially with April — historically the second most bullish month of the year — around the corner. However, a move towards 490 or even 480 post-expiration is plausible, where the 50- and 80-day moving averages loom if the round 500 level can be breached.
From a broader sentiment standpoint, we’re also starting to see optimism at extreme levels in some of our longer-term sentiment indicators. The Investors Intelligence (II) bulls minus bears ratio is 43.4%, its highest level since mid-2021. This puts readings in the 95th percentile, and historical returns going forward often underperform the average return over the next year.
The thing about a bull market is that you need people to be bullish for it to continue. So, while we may have reached nosebleed levels on some longer-term sentiment indicators, they can remain elevated for an extended period, unwind some optimism through a slight 3-5% pullback, or mark a top for a much larger correction. This doesn’t undermine the data; it simply tells us to be cautious with adding exposure and to wait for safer levels to trade against.
To sum it all up, equities have been on a great run. It’s not necessarily over, and it’s too soon to call a significant turn despite some barriers. I would be cautious to add long-term bull bets except in individual names that could see money rotate towards, but continue to buy short-term pullbacks at defined levels in momentum names for quick trades until we get a better risk/reward opportunity. If you’re worried the market is too extended, you can always add a hedge through SPY puts and use last week’s high or a close above $520 as a stop level.
Matthew Timpane is the Senior Market Strategist at Schaeffer’s Investment Research.
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