The 80-, 200-, an 320-day moving averages could all be significant in the coming months
The S&P 500 Index (SPX - 3,298.46) finished this week down by 0.6%, and down for the fourth week in a row to the tune of 5.8%. It did, however, pull out a last-minute stick save and managed to rally above the 80-day moving average. In our opinion, the 80-day moving average is an important potential signal for where the market is going next in the near-term. If we were to break below the 80-day moving average early next week, we could trade down another 6% to the 200-day moving average, or even the 320-day moving average in the near-term. This happened in both May 2019 and September 2019 when the market was acting weak. In both cases, an initial pullback was supported by the 80-day moving average and previous high, but eventually broke down, only to find the 80-day moving average acting as resistance before a deeper correction.
Furthermore, this level corresponds with the 23.6% Fibonacci retracement level, and the Feb. 24 gap down a level. These are crucial levels that need to hold for the bull rally to continue and prevent panic selling down to the 3,100-3,000 range in the S&P 500. For bulls to get an all-clear, they will need to see the market break out of the recent downtrend early next week, and above 3,320, which would put the recent highs in their sights. In other words, next week will be a battlefield for both bears and bulls to see who prevails.
Another noteworthy observation has been how negatively correlated the US Dollar Currency Index (DXY -- 94.58) has been to stocks, gold, and even bitcoin, with the current reading of -0.85. In the chart above, I have inverted the dollar to show how strong this trend has been since the March lows. You can see that all three asset classes have been highly correlated in their ascent, but it appears that the dollar is in the driver’s seat for now. One important factor that led to this rapid recovery in the markets was the massive liquidity injection from the Federal Reserve and fiscal stimulus bills from Congress. Now that the Fed and Congress have laid off the gas in terms of stimulus, we’re seeing the dollar strengthening again. This is pressuring assets on top of many economic growth indicators slowing, hitting a wall, or even seeing declining data. With the threat of volatility over the next few months surrounding the election, I wouldn’t be surprised to see the Fed interject once again to ensure ample liquidity in the market, at which point, I would assume the dollar would resume its downward trajectory.
So, let’s look at the dollar quickly. A while back, we discussed how important the 80-month moving average was to the dollar. After failing to hold the important moving average, over this past month, we’ve now seen a rally back to it to test the breakdown in a massive short-covering rally. Previously, 80-month moving average break downs on the dollar have all seen large declines in the following months, so will it be different this time? It’s hard to imagine that it will be, with the easing measures that have already taken place. Still, there is risk that additional stimulus to support those that have been hurt by this recession doesn’t get done until after the election. Following the election, both parties will likely want to do something, and if the Democrats gain control, we’d likely see a massive stimulus package. Until then, it’s prudent to watch the dollar to give us an additional hint to where the market is going in the near-term.
It is usually sometime after that two-week period that the remaining bulls are flushed, setting the market up to rally by day 21 after the signal. As a side note, it is hard to overlook the last time a signal like this appeared in February, as the implications of the impact of the global pandemic wreaking havoc on world economies became clearer.
- Monday Morning Outlook, September 21, 2020
From a sentiment standpoint, there are still some downside risks, but we’re also entering an area for a potential market bounce. Therefore, we urge prudent readers to be cautious but open-minded, as this bull rally may not have ended just yet. When looking at the 10-day buy-to-open, equity-only, put/call volume ratio reading at 0.43, it’s hovering near last week's levels. However, we’re still low enough to be considered in the extreme optimism zone to warrant some caution for traders. Additionally, our Senior Quantitative Analyst, Rocky White, recently did a study where he smoothed this indicator out to the 20-day, and the data supports our cautious attitude towards the market. Looking at the 3-month time period following extreme lows, the S&P 500 was down on average by 1.7% and only positive 52.3% of the time.
One misconception market participants may have is that we need to see retail traders ratchet up their put buying in order for the put/call ratio to move to the high-end of readings. While put buying activity may very well increase, when we drill down, it appears what we really want to see is exhaustion in call buying activity. Buy-to-open call buying volume is already down by 3.22 million or 21.1% from its recent peak, which could be enough for the market to bounce.
A segment of the market that clearly rotated out of stocks is active investment managers, per the weekly National Association of Active Investment Managers (NAAIM) survey, which asks respondents to disclose their net exposure. After moving into a slightly leveraged long position in mid-August, this group aggressively sold stocks last week. In fact, the one-week drop in exposure was the second largest in the history of the survey (a week in January 2008 saw a slightly larger drop). Net exposure at present, while not at an extreme low, is at levels that have defined bottoms on some pullbacks. The jury is out as to whether this group continues to decrease equity exposure to extremes like 2015, 2016, late 2018 to early 2019 and earlier this year.
Monday Morning Outlook, September 14, 2020
As we previously alluded to, the National Association of Active Investment Managers Index (NAAIM) had a historic drop on a points basis as active managers fled to the sidelines in the equity markets a couple of weeks ago. In the past, such rapid drops have been a positive for the bulls. Personally, I like to put the two-week percentage change on the index to signal oversold conditions. What I look for is a move below -40%, as this has been a level where we’ve seen market bottoms previously. Unfortunately, the ultimate bottom can happen up to a month later. So, while it’s not the greatest timing tool in our arsenal, it does give us a hint that we should be watching out for a bounce while understanding there is still a possibility of a few more weeks of downside risk.
To conclude, the market is searching for direction, and the recent declines may very well be overdone in the short-term, setting us up for a rally, but the correction might also not be over. It would be prudent for market participants to remain nimble here and play what the market gives you.
Matthew Timpane is Schaeffer's Senior Market Strategist
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