“… the SPX briefly traded above its early-September closing high of 3,588, though momentum stopped right there, as the index fought to overtake this resistance level… In fact, the index closed back below 3,553 on Tuesday and Thursday, which corresponds to a 10% gain for the index, and a level I have been saying could be important for weeks.”
- Monday Morning Outlook, Nov. 16, 2020
The S&P 500 Index (SPX – 3,557.54) has experienced its best price action this year, after a close above or a run at 3,553 on Sept. 2, which comes in a round 10% above its 2019 close. This level has been a thorn in the side for bulls, as it marked the beginning of a three-week, 9.3% retreat. Another run at this level occurred on Oct. 12, with the intraday high just shy of the 3,553 level, before a 7.5% pullback of similar duration. And after again enduring resistance in that area from Nov. 9-12, the SPX has experienced six consecutive closes above this level.
For what it is worth, 3,560 is 10% above the September closing low, which likely added another profit-taking mentality in mid-October among those that viewed the rally as being “too far, too fast.” One obvious uncertainty that was lingering in September and October was removed with the election in early November, but that was not enough to push the index through resistance.
Since the election, final stage trials of two COVID-19 vaccines have proven candidates to be more than 90% effective. Meanwhile, other drugs have received emergency use authorization from the Federal Drug Administration (FDA). Such developments have resulted in less sellers in the 3,553 area, as investors see a light at the end of the tunnel in conquering a virus that has stunted some, albeit not all, areas of the economy.
At the same time, COVID-19 infections are growing at a worrisome rate in the eyes of some government leaders and, as such, restrictions are coming back, although not at the same levels of spring. This has given buyers some pause, in the absence of further stimulus.
“Industry analysts have warned that Mr. Mnuchin’s decision would risk unsettling markets—which for various reasons have been volatile around the end of recent years—by weakening a key source of assurance that fueled investors’ optimism, especially as the economic recovery slows amid rising coronavirus cases.”
- The Wall Street Journal, Nov. 20, 2020
Moreover, on Friday, U.S. Treasury Secretary Steve Mnuchin decided not to extend lightly used emergency lending programs designed to expire at the end of the year, per the Coronavirus Aid, Relief, and Economic Security (CARES) Act. In his letter to Fed Chairman Jerome Powell, the secretary said, “banks have the lending capacity to meet the borrowing needs of their corporate, municipal and nonprofit clients.” In a CNBC interview, Mnuchin said he has been in constant talks with Powell, and that he hopes the money can be re-directed to those that need it most. Nonetheless, Powell voiced disappointment at Mnuchin’s decision.
“the Nasdaq Composite (IXIC – 11,829.28) briefly traded above the 12,000 level, but was ultimately rejected, as investors bid up stocks that could benefit from economic growth as a result of the vaccine, and rejected technology stocks that are the drivers during stay-at-home orders.”
- Monday Morning Outlook, Nov. 16, 2020
The good news for bulls is better price action for the SPX around the level that corresponds to a 10% year-to-date gain, and another level that is 10% above its September closing low. Another perspective reveals an index that has been a trading range since its early-September peak at 3,580.84.
While there were two closes above this level and the round 3,600 century mark last week, the SPX closed back below 3,580 on Friday. In fact, since the mid-August breakout above the February closing high of 3,380, most closes have been between 3,380 and the early-September 3,580 peak, implying we are entering the Thanksgiving holiday week nearer the top of a three-month trading range.
Similarly, the Nasdaq Composite (IXIC – 11,854.97) has been locked in a range during the same period, with the bottom of the range at the 11,000-millennium mark, and the 12,000-millennium level defining the top. Sellers do not appear to be as powerful relative to past trips up to 12,000, however, which is perhaps indicative of a breakout.
While the SPX and IXIC are facing obvious resistance on the charts, Friday’s decline from these levels was not as bad as one might have expected after Jerome Powell voiced disappointment with Mnuchin’s decision on the lending facilities, and industry watchers voiced caution.
Short-term clouds have emerged, though, even as an end to the pandemic seems to be within reach. For instance, rising COVID-19 infections and hospitalizations have prompted some states to reinstate restrictions. This naturally leads to questions as to whether, and when another stimulus package will follow, since the obvious impact is a slow-down of the economy (in fact, J.P. Morgan Chase (JPM) forecast negative first-quarter growth on Friday).
As such, it is evident that over the course of the week, investors hit the pause button. Nonetheless, and perhaps more importantly, they were not heavy on the sell button, as positive vaccine news is likely supporting the market as well as the longer-term health of the economy.
“A net 46% of fund managers are overweight equities — the highest share since January 2018…Fund managers’ cash holdings fell below the pre-pandemic level — and are at the lowest in five years.”
- Bank of America/Merrill Lynch Fund Manager Survey
On the sentiment front, there is optimism that is equivalent to levels that have recently preceded pullbacks. More specifically, the National Association of Active Investment Managers (NAAIM) weekly survey showed average exposure at 106.41, which is fully invested with a little leverage. In mid-October, ahead of the SPX’s 7% retreat, this reading was at 102.93. This survey supports findings in Bank of America’s (BAC) monthly fund manager survey.
Per the chart immediately below, the 10-day, equity-only, buy-to-open put/call volume ratio -- while not at an extreme low, indicative of optimism relative to the past couple of months -- is at a level that has preceded short-term pullbacks since January 2018.
If the SPX and IXIC are on the verge of a breakout, it will have to come as market participants grow even more bullish, as such bullishness represents growing market risk. Therefore, with the CBOE Market Volatility Index (VIX – 23.70) hitting its lowest levels since August last week, one might use index put options to hedge long positions, amid the sentiment-based risk factors.
SPDR S&P 500 (SPY – 355.33) options that expire in mid-January are reasonably priced at 20% implied volatility (IV), which is in line with 40-day historical volatility. If you have heavy technology exposure, Invesco Trust QQQ Series (QQQ – 290.38) mid-January options are priced reasonably too, at 24% implied volatility, which is below the exchange-traded fund’s 27% 40-day historical volatility (HV).
Still, market surprises might include heavier-than-anticipated restrictions amid higher-than-expected hospitalization rates, or a negative decision by the FDA on one or both COVID-19 vaccines, as recent data was so promising that investors have positioned themselves for a positive outcome within the next couple of weeks.
Todd Salamone is Schaeffer's Senior V.P. of Research
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