The best course of action is to stay the course, as rallies often persist longer than most participate
“Our own Senior Quantitative Analyst Rocky White looked back at the historical implications of the SPX breaking out to new all-time highs after going more than a year without achieving this milestone. The historical results using data since 1954, … are unambiguously bullish over the several time frames measured…”
– Monday Morning Outlook, January 29, 2024
More than a year removed from an all-time high, the S&P 500 Index (SPX-4,958.61) broke out above its January 2023 all-time closing high at 4,796 two weeks ago, after a brief hesitation at this level beginning in late-December and into mid-January.
Exactly two weeks after the January 19th breakout, using the 4,840-closing level on the day of the breakout, the SPX rallied 2.7% by utilizing Friday’s close. In prior instances that the SPX broke out to a new all-time high after more than a year of not doing so, the index rallied 71% of the time two weeks later, per the study displayed in last week’s commentary. But the gain in this two-week period was nearly double that of the 1.5% average gain in instances the SPX was higher in the14 previous occurrences. As such, the SPX followed historical script in terms of the probability for it to rally.
Looking out two weeks and based on the average SPX return of 2.38% when it advances in the one month following a breakout to a new all-time high, the SPX will be at 4,955 if the current data point coincidentally lands on its historical average.
“One level I am watching overhead is 4,940, which is 20% above the October closing low. If a pullback occurs, the first level of potential support is around 4,800, the area of the all-time high in January 2023. The important and rising 30-day moving average is currently just under 4,800, and based on the current slope, will be situated at 4,815 at this time next week. Stay the bullish course… continued short covering could keep pullbacks to a minimal level if buyers suddenly go on strike, albeit bulls would love to see continued short covering drive the SPX higher.”
-Monday Morning Outlook, January 29, 2024
In previous weeks, I have mentioned the high short interest level on SPX component stocks, as short interest hit a multi-year high in December, with evidence of covering activity in recent weeks that I anticipated would be supportive of the market.
I would imagine short covering is still supporting the market, as the SPX easily sliced through a level of potential resistance at 4,940 last week. Bears are likely panicking, as there was not profit-taking at 4,940, which is 20% above the October 2023 closing low. That said, note on the graph below that when the SPX moved above the level coincident with 10% above its October closing low, a two-week consolidation period occurred before the next leg of the rally.
Plus, on the monetary front, despite expectations that a rate cut could come as soon as March, Chairman Powell threw cold water on this outlook after the Federal Open Market Committee (FOMC) decided to pause again on raising rates in Wednesday’s meeting. This caused a one-day swoon in favor of the bears, but that was it.
In fact, he clearly stated in his press conference that he does not expect a rate cut in March, but he did confirm what was perceived as a pivot away from more rate hikes after the FOMC last met in mid-December and prior to last week’s meeting.
Market participants appear to be focusing on surprising economic data that came out prior to the FOMC meeting last week, which suggests inflation is headed back to the Fed’s 2% target amid continued strength in the economy.
In other words, even though Chairman Powell warned market participants last year that pain may be coming due to the Fed’s ongoing effort to reign in high inflation, such pain has not yet materialized. This “soft landing” scenario that is playing out at present is apparently catching skeptics off guard.
Speaking of skeptics, as the rally continues amid overbought conditions for the most part since mid-January, there is still a “too far, too fast” and “what goes up, must come down” mentality among short-term option players on SPDR S&P 500 ETF Trust (SPY-494.17) options.
Per the red below, there were more put open interest additions (red) than call open interest additions (blue) in the five days prior to the expiration of the Friday, February 2 expiration options. More red bars than blue bars has been the case since the early stages of the rally.
If a top is in place and put players continue to be predominant, it will be a case of “the blind squirrel has finally found the nut,” or such a scenario might happen after we see short-term put buyers disappear relative to call buyers.
The best course of action when momentum like this occurs is stay the course, as rallies will persist longer than most anticipate. That said, anything can happen in the short term, so be open to all possibilities. The first level of key support is the 4,800 area, site of the former all-time high and the 30-day moving average.
The 5,000-millennium level is now in sight and poses a potential hesitation or pivot point. In April 2021, the SPX shot right through 4,000, rallied strongly to its January 2023 all-time high, but by May 2022 revisited 4,000 ahead of a choppy, volatile period for months. The SPX’s next big round number is in view just a few weeks after the Nasdaq Composite pushed through 15,000 in mid-January.
Todd Salamone is the Senior V.P. of Research at Schaeffer’s Investment Research.
Continue Reading: