Will the Recent Dip Draw Fund Managers Out of Hiding?

Checking in on the DJI, SPX, COMP, MID and more

Senior Vice President of Research
May 4, 2015 at 9:32 AM
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"Friday marks 57 consecutive days in which this volatility-expectation measure closed below its year-to-date breakeven point.  Since 1990, there have been only three prior instances in which the VIX experienced 50 consecutive closes below the prior year's close (1991, 1998, 2012) before May ... while in two of the three previous instances the market struggled in the short term (1-3 months), the SPX also went on to rally by a double-digit percentage into the rest of the year."
-- Monday Morning Outlook, April 27, 2015

Thanks to last week’s pullback in the market, the S&P 500 Index (SPX - 2,108.29) is now sitting around the same level as its April 16 close of 2,104. April 16 marked the 50th consecutive day in which the CBOE Volatility Index (VIX - 12.70) closed below its year-to-date breakeven point, and even though there have been few historical examples of such a streak occurring early in the year, we observed the market has struggled in the short term following such a streak.

In fact, last week, weaker-than-expected economic data and a few earnings disappointments drove equity benchmarks such as the Nasdaq Composite (COMP - 5,005.39), Dow Jones Industrial Average (DJIA - 18,024.06) and SPX back below round-number resistance levels that were overtaken in the previous week's trading. With the Federal Reserve still stressing that it remains data-dependent with respect to the timing of a rate hike, it appears investors perceive a Fed that could raise rates by year’s end, suggesting little tolerance for weak economic data points. 

Friday’s rally reversed what appeared to be a disturbing picture by Thursday’s close.  For example, the Russell 2000 Index (RUT - 1,228.11) broke below support from its 80-day moving average for the first time since December, but Friday’s rally pushed the index back above this trendline. In the event that the 80-day moving average doesn’t serve as a launching point in the coming days and the RUT falls below last week’s lows, we’ll be watching the 1,200-1,210 area closely, which is home to a round number and its former highs. The RUT is approaching an oversold condition (second pane in chart below, 14-day Relative Strength Index), but is at risk of lagging larger-cap foes if the dollar continues to weaken.


And while the SPX and COMP retreated back below round-number levels last week, the SPX rallied on Friday to close back above 2,100, while the COMP advanced impressively to close the week back above 5,000.

Furthermore, the DJIA experienced an impressive bounce from its year-to-date breakeven zone in the 17,800 range to reclaim 18,000, while the S&P 400 Midcap Index (MID - 1,513.51) held the round 1,500 level in Thursday’s trading. Looking ahead, recent highs present potential short-term resistance levels for the major equity benchmarks. 

DJIA -- another bounce from YTD breakeven support, a level that acted as resistance earlier this year


Fortunately for bulls, even if stocks retreat back below round-number levels and last week's lows, there are other areas of potential support just below. For example, 2,059 on the SPX is the site of its 2014 close, as year-to-date breakeven levels have proven to be pivotal. And the 4,825 area on the COMP is the site of its 120-day moving average and late-2014 resistance. You can see the importance of the 120-day moving average, which corresponds to roughly six months of trading, on the chart below.


Also of interest within the current trading range is how multiple equity benchmarks are respecting round year-over-year (YoY) percentage return numbers. For example, the COMP’s pullback appears to have found "support" at the 20% YoY return level, currently around 4,900. The COMP has "danced" around this YoY return level since mid-February. 

Meanwhile, the DJIA has been sold at 10% YoY, while the MID 10% YoY has been bought on pullbacks. If these benchmarks close the month at their respective round-number YoY percentage returns like they did in April, you would expect to see the DJIA at 18,388, the MID at 1,515 (about where it is now), and the COMP at 5,090, roughly 42 points below its 2000 intraday high of 5,132.

150501MMO_SPX Options

A potential headwind that we see in the short term resides in the sentiment of short-term traders, who -- as exemplified by action in the options market -- recently hit a seven- month optimistic extreme. But sentiment in this group is turning fearful, and could present a headwind. The 10-day equity-only buy-to-open put/call volume ratio, as displayed in the chart below, is turning higher from a seven-month low, which means equity put buying (a downside speculative bet or long equity hedge) is higher relative to call buying (an upside speculative bet or a hedge to a short equity position). Previous such shifts in sentiment have preceded market weakness. There is a chance that if equities quickly recover from last week's pullback, this ratio turns lower again and eventually reaches lows from early 2014. 

For now, this shift in the sentiment among short-term traders remains a risk to the market. That said, we don’t expect a deep pullback, as there are a plethora of fund managers sitting on a heavy cash position and waiting to use this cash to buy stocks on a pullback. Only time will tell whether or not last week’s pullback was the opportunity that these fund managers were seeking.

The turn higher in the buy-to-open put/call volume ratio signals a shift in short-term trader sentiment from optimism to pessimism


Finally, with May upon us, seasonality is something that you have likely heard or read about in recent days. The "Sell in May and Go Away" adage is a popular phrase on Wall Street, and Rocky White, our Senior Quantitative Analyst, discussed this axiom in detail last week on our site. We would recommend reading this commentary if you have not done so already. 

A table that caught my attention in his commentary is reproduced below, and it suggests that we may be selling too early during the past 40 years, as the average returns are higher in May-July than August-October. Plus, volatility, as measured by the standard deviation of returns, tends to be higher in August-October than the May-July period. Furthermore, in a separate study that Rocky did for us, May has been higher 60% of the time since 2000 -- better than five other months, including January and February. 

The point of these studies is not necessarily to suggest that May will be positive in 2015, as May could very well be a down month. But at the same time, the "Sell in May and Go Away" approach doesn't historically appear to be as "optimal" as advertised. Moreover, it is not a "slam dunk" approach to optimizing your portfolio returns.

150501MMO_SPX Summer

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