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1994 and Now: The Similarities (and Differences) May Surprise You

What the bond yield spread could mean for stocks

by 5/10/2014 9:16:50 AM
Stocks quoted in this article:

The bulls and bears continued their tug-of-war for control, amid geopolitical wrangling, policy talk from Federal Reserve officials, and the latest barrage of corporate earnings reports. By the time the dust settled, investors were left with a sense of déjà vu, as blue chips outperformed -- the Dow Jones Industrial Average (DJI) ended Friday at a new closing high -- while momentum names struggled. This continued resiliency of the Dow and the S&P 500 Index (SPX), amid weakness in riskier names, could actually be an encouraging sign, as Todd Salamone discusses this week.

  • Is 2014 simply 1994 all over again?
  • Revisiting significant levels to watch across the major indexes and ETFs
  • The bond yield data you don't want to miss.

Finally, we close with a preview of the major economic and earnings events for the week ahead, plus our featured sector.

Notes from the Trading Desk: The S&P 500 Is "Holding Its Own" as Riskier Names Retreat
By Todd Salamone, Senior VP of Research

"AAII 28% bulls- sub-30 bull reading in back-to-back weeks. Last time this occurred was April 10th and marked short-term bottom"

"$RUT - 10% correction from 3/4 intraday peak at 1212.82 is at 1,091.53. This morning's low was 1,091.50 and index is back above 1,100"

"$VIX put volume lower than 98%of daily readings during past 52 weeks- Very few looking for lower vol with $SPX barely off record high"


-@ToddSalamone on Twitter, May 6-9, 2014

Besides ending in the number "4," what do 1994 and 2014 have in common?

How about the CBOE Volatility Index (VIX - 12.92) spending a majority of its time in the 12 area and generally finding a floor around the previous year's close, with occasional pops to 17 and 18. And, in the context of 1994's low-volatility environment -- and after an early 1994 pullback of less than 10% that ended in April -- the S&P 500 Index (SPX - 1,878.48) traded in a range, as it is doing currently.

But technology and small-cap stocks, as measured respectively by the Nasdaq Composite (COMP - 4,071.87) and Russell 2000 Index (RUT - 1,107.22), slid beyond "official" correction territory, finally hitting their respective bottoms in June 1994, two months after the SPX bottomed. The COMP experienced a 14.1% setback before it was over, while the RUT fell by 11.3%. In the current environment, the SPX is trading in a range close to its highs, even as the RUT and COMP continue to experience weakness and remain well off their March peaks.

The similarities do not stop there, as in both 1994 and 2014, the benchmarks discussed above hit all-time high territory just ahead of their respective short-term pullbacks, and in both years, the pullbacks began in the first quarter.

But there are also differences, which bulls may find encouraging. First, throughout much of 1994, the top of the SPX range (acting as resistance) was defined by the index's year-to-date (YTD) breakeven level. But, in 2014, the 2013 close has generally been supportive of pullbacks.

Another difference is, in 1994, stocks sold off under the weight of sharply increasing interest rates, as defined by the yield on the 10-year note (TNX), which rose almost 200 basis points from January-May. At present -- and despite Fed tapering and expectations for higher interest rates -- the yield on the TNX has been range-bound between 2.60% and 2.80% since early February. Finally, the steepest slide in the SPX in 2014 has been about 4%, which is not even close to the official 10% correction territory. Quite frankly, the lack of a correction since 2012 has some market technicians scared, since the SPX is now "long overdue" for one.

As a side note, prior to the SPX's "near" correction in 1994, the SPX hadn't experienced an "official" 10% correction since June-October 1990. The next "official" correction (a decline of at least 10%) did not occur until May-July 1996. So, it was a six-year period between corrections of 10% or more in the SPX from 1990-1996. A "glass-is-half-full" mentality would point to this six-year period between 10% corrections in the SPX as a reason to remain confident, as calls for a correction get louder.

Finally, and as you can see on the charts below, even though the SPX is locked in a range like 1994, it is trading nearer its highs of the year, whereas the RUT is around its lows of the year. It is unclear exactly what this means, other than a bull can easily say that the SPX's resilience suggests the worst might be over for the more risky areas of the market, whereas a bear might say the SPX is "on deck" for a nasty spill. Stay tuned.

Sharp sell-off in February, followed by April – June range with higher lows from early April to June; horizontal line marks YTD breakeven
SPX daily chart from January 1994 to June 1994
Chart courtesy of StockCharts.com

Peaked one month after SPX, bottomed two months after SPX
RUT daily chart from January 1994 to June 1994
Chart courtesy of StockCharts.com

Both peaked around same time, SPX in range nearer its highs as RUT threatens new lows and is well off its highs
SPX daily chart since January 2014
Chart courtesy of StockCharts.com

RUT daily chart since January 2014
Chart courtesy of StockCharts.com

As we have said many times, stocks have performed best when leadership is coming from the small-cap "risky" names. That said, the SPX has shown historically, and at present, that it can "hold its own" amid weakness in the risky names. If the current environment plays out like 1994, the present strength in the SPX would be a prelude to risky names carving out a bottom. We will likely have to see stability in the risky names before the SPX can muster a breakout above the important 1,880 level, which is 20% above the highs that preceded the two bear markets that began in 2000 and 2007.

With RUT support at the important 1,100 century mark (a potential "double-bottom"), and the index finally reaching official correction mode with Friday's lows, buyers may emerge. This action may lift the RUT and concurrently push the SPX above the critical 1,880 level.

From a contrarian perspective, the short-term sentiment backdrop is supportive of equities, as rallies usually occur when least expected. Retail players aren't expecting a rally, nor are option speculators, as is evident from the lack of equity call buying relative to put buying (see chart below). Additionally, the consensus thinking is that the VIX will not move lower, as is evident by pitiful put volume on VIX futures options.

The fact that equities spent most of the year in a range in 1994 is certainly another scenario to weigh, especially within the various technical support/resistance levels we have been discussing the past several weeks. For example, the Wilshire 5000 (W5000 - 19,867.21) has experienced repeated failures to sustain a move above the 20,000 millennium level since March. In fact, the W5000 peaked precisely at this level twice in the past trading week. Moreover, the popular PowerShares QQQ Trust (QQQ - 86.80) and Dow Jones Industrial Average (DJI - 16,583.34) have repeatedly failed to sustain moves above their respective 2013 closing levels at $87.96 and 16,576.66.

On the other hand, important benchmarks, such as the S&P MidCap 400 (MID - 1,353.79) and SPX, have found support at their YTD breakeven levels (1,342.53 and 1,848.36, respectively). Meanwhile, the COMP's 4,000 millennium level and the RUT's 1,100 century level have been supportive. The bottom line is that psychologically-important round numbers and 2014 breakeven marks have come into play on several benchmarks and at varying times, leading to range behavior that might persist longer than desired.

But from a short-term perspective, we could be setting up for a rally, which would surprise short-term traders, as we alluded to above and which we quantify on the chart below. A potential catalyst for a rally next week is expiration, especially if the iShares Russell 2000 ETF (IWM - 110.03) and SPDR S&P 500 ETF Trust (SPY - 187.96) remain above the put-heavy 110 and 187 strikes, respectively. If these benchmarks remain above these strikes, a short-covering tailwind could occur related to the expiration of the puts.

Equity option traders are mostly sour on the market at present – such sentiment within this generally precedes bullish price action
S&P 500 Index and 10-day buy-to-open call put volume ratio since May 2013

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