“…the SPX broke below its 36-month, or three-year, moving average… this long-term moving average has proven to be historically important when evaluating it on a month-end close, which is timely given that Tuesday marks the end of the October calendar month…in months where the SPX pulls back to or below its 36-month moving average but closes above this same moving average at month end, it usually marks a bullish turning point... a risk is ignoring the lengthy sell signals that have occurred historically after month-end closes below the SPX’s 36-month moving average. As such, one may lighten up on equity allocation or hedge long exposure via longer-term index or exchange-traded fund put options to address such a possibility.”
-Monday Morning Outlook, October 20, 2023
In last week’s commentary, I spent considerable time discussing the historical importance of the S&P 500 Index’s (SPX — 4,358.34) 36-month, or three-year, moving average as buy and sell signals, with an emphasis on month-end closes above or below the trendline.
Heading into last week’s trading, the SPX was dangerously close to settling below its 36-month moving average, which in a best-case scenario was a short-term sell signal and a worst-case scenario of a long-term sell signal.
However, the index rallied strongly in the last two days of October, and the SPX closed above its 36-month moving average. Since June 2022, the index has traded below this trendline intra-month in nine of those months, with only one meaningful close below it.
An immediate and significant rally followed into the end of July only in March 2023. If recent past is prologue, the probability favors a muted rally. But one should be open to the longer-term tendency of a new high being achieved after the month-end close above long-term moving average support.
The multiple tests of the 36-month moving average is somewhat similar to the 1987-1988 period, when the index sloppily recovered from the 1987 crash trough. During that period after the crash, the SPX touched its 36-month moving average in seven of the 13 months following the crash, but there were not nearly as many intra-month breaks below that trendline as we are experiencing in the current environment.
For those of you that were patient and used the SPX’s month-end close to decide on your next actions, you were rewarded for taking a bigger-picture view and exercising patience into the end of October.
Lightening up on equity exposure or spending money on a hedge with the Cboe Market Volatility Index (VIX — 14.91) — a measure of how costly portfolio insurance is — at multi-month highs was not necessary at month-end. Moreover, those that panic-sold last week missed out on a 6% surge in the SPX.
As such, long-term bulls should stay the course.
“At risk of drawing lines in the sand, the 4,100-4,115 could mark a pivot, if only in the short term. This area is the 61.8% Fibonacci retracement of the March 2023 low and July 2023 peak, in addition to an area of major sideways movement within a narrow range from early-April through late-May. Will buyers in April and May that got in before the May-July rally take a stand here?.. I see major resistance between 4,200 and 4,225, the latter of which was identified as potential support in previous commentaries..”
-Monday Morning Outlook, October 30, 2023
Per the excerpt above, the SPX support area between 4,100 and 4,115 indeed marked a major pivot area and preceded an impressive rally above potential resistance in the 4,200-4,225 zone (the upper part of that zone is the round 10% above the 2022 close).
The index rallied above its 50-day and 200-day moving averages at 4,350 and 4,245, too. Sellers briefly emerged at the 200-day trendline late Wednesday.
Now what? Per the chart below, potential resistance resides immediately overhead at last month’s highs around 4,380. Trendline resistance connecting lower highs since late July comes into the week at 4,407 and at 4,395 on Friday.
“The Cboe Market Volatility Index (VIX-21.27) is still refusing to move above its 2022 close at 21.67, even as the SPX has declined to its lowest level since May and ahead of an FOMC meeting next week. If the VIX ultimately peaks at this level, it could be a win for bulls during this bullish seasonal period for stocks…. bulls should suspect rallies that occur without a VIX move below 19.23. ”
-Monday Morning Outlook, October 30, 2023
While rallies have been sold since August, this does not mean that you should sell equities as the SPX approaches potential resistance. If rallies continue to be sold, you can better manage risk with the VIX reading currently 30% below its recent peak, which occurred at its 2022 close.
In other words, it is much cheaper to hedge long portfolios by purchasing index or equity exchanged-traded fund (ETF) put options relative to late October. This is appealing if you are concerned about the resistance levels discussed above coming into play.
Additionally, it is nice buying this protection early in the month to proactively guard against a scenario in which the SPX crashes through its 36-month moving average, with a decent time left until the end of the month when it is best to evaluate its close relative to this trendline. Portfolio protection addresses the uncertainty of whether such a decline is another fakeout move before an end-of-month close back above it, or an eventual sell signal.
That said, the VIX has plenty of room to move lower when anchoring to past lows this year in the 12.50–13.00 zone. Buying portfolio protection in this region in this market environment is optimal. Then again, buying portfolio protection with the VIX at 15.00 is better than buying portfolio protection with the VIX at 21+.
Todd Salamone is the Senior V.P. of Research at Schaeffer’s Investment Research.
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