"With the S&P 500 Index's end-of-August close below its 20-month moving average, the bears have a little more ammo to make their case. As we noted last week, monthly closes below this trendline during the past 40-plus years have historically preceded additional short-term weakness amid increased odds of prolonged weakness ... [B]ounces -- or retests -- of the trendline have a tendency to occur, so one should not be surprised if the SPX finds itself retesting this trendline sometime over the course of the next few months … For those with a short-term mindset, be sure you have exposure to short, sharp moves in either direction, especially with a Fed meeting on the calendar next week."
-- Monday Morning Outlook, September 8, 2015
Last week, we discussed the historical implications of the S&P 500 Index's (SPX - 1,961.05) close below its 20-month moving average. Essentially, higher volatility in the months ahead has followed such breakdowns, with a lower-than-normal probability of a higher market 12 months down the road. That said, the probability of higher market is still slightly more than 50%, compared to the normal 75%.
In the short term, the market has averaged slightly negative returns, on average, one and two months later, with the SPX being lower 55% of the time two months later, compared to a 37% expectation of being lower in "normal" times. Nonetheless, the SPX has made a couple runs during the past two weeks at moving into positive territory for the month of September, despite a horrendous start to the month. But, as you can see on the 30-minute chart below, intraday moves into positive territory for the month have been met with heavy selling activity.
The month-to-date (MTD) breakeven point on the SPX is at 1,972.18. In fact, the September 2014 monthly close was at 1,972.29. Therefore, both MTD and year-over-year (YoY) breakeven levels have come into play as resistance points during the past couple of weeks, and, therefore, this is a level we will be watching closely in the days and weeks ahead.
Moreover, as we said last week, retests of the longer-term 20-month moving average usually follow soon after a breakdown. With that said, last week's intraday high was at 1,988.63, less than 12 points below the important 2,000 round level, which is also the site of SPX's 20-month moving average.
The point is that while the SPX sits well above the late-August low of 1,867, attempts to rally above the resistance areas identified above have failed. This implies the current technical backdrop is working against the bulls, whose hope at the moment is a favorable sentiment backdrop.
"… a few major equity benchmarks now sit 10% below their respective peaks. Perhaps the next line of support -- 10% below highs? ... If you are thinking about buying into this decline, consider waiting for the VIX to close below 23.90 and/or the SPX to close above the round 2,000 level. Typically, round numbers have held as support, but this did not pertain to the SPX during expiration week. Plus, we view 2,000 as important because it marks three times the October 2009 low."
-- Monday Morning Outlook, August 24, 2015
With resistance established overhead during the past couple of weeks, a support area has been building on the SPX, too. Specifically, the 1,917 area on the SPX, which is 10% below the 2015 closing high at 2,130.82, has marked two lows. This price action has resulted in a trading range, as we move into a potentially pivotal week ahead.
But before discussing next week, note that the CBOE Volatility Index (VIX - 23.20) had been establishing a floor at 23.90 since the 50-plus peak just a few weeks ago -- that is, until the last 30 minutes of trading on Friday. As we discussed last month, bulls would like to see a sustained move below this level, which we think is significant because it is double the 2015 closing low and thus a level that might seem "expensive" to anyone anchoring on the mid-July closing low of 11.95. An even "safer" bet for a volatility decline at this point would be a close below 20.37, which is half the recent closing high. A risk for bulls is volatility players anchoring to the recent highs and viewing the "half high" in the 20-plus area as a cheap way to play a volatility move higher, especially with the market sitting in the middle of a range.
"Get a lot of rest this weekend because next week is going to be huge. Obviously the main event (by far) will be the Fed rate decision on Thursday. By now everyone should know the context … Other than that, there's a ton of economic data next week including the retail sales report for August, Empire Manufacturing, Capacity Utilization, CPI, NAHB, Housing Starts, and The Philly Fed Business Outlook. So to repeat, rest up!"
-- Bloomberg, September 11, 2015
In addition to the Fed meeting and a full economic calendar, next week also brings the expiration of standard September options, including September VIX options that expire on Wednesday morning (last day to trade them is on Tuesday). As you already know, some economists expect the Fed to hike rates at the upcoming meeting. There is much uncertainty heading into this meeting, so option premiums on index options are likely priced a little higher than usual, inflating the VIX somewhat. A rate hike before the end of the year is pretty much baked into the market, which negates the surprise element if and when the Fed does raise rates.
With the Fed and a heavy economic calendar during a standard expiration week, reactions to data could be exaggerated. Some of you might remember that we speculated last month's huge decline could have been exacerbated by expiration week mechanics. As a refresher, if something sparks selling in the market, heavy put open interest below the market can sometimes act as a "magnet," as sellers of the puts are forced to short more and more equity futures as the index approaches put-heavy strikes. Such "delta hedge" selling may have played a part in the August melee. At the same time, if the SPX is able to hold above put-heavy strikes into expiration, short covering related to the expiring put open interest at strikes below the market could generate a tailwind for the market.
Therefore, our best advice to traders is to be prepared for both scenarios. And for investors with a longer time horizon, be careful not to overreact to sharp sell-offs during expiration week that are partly expiration-week driven, as the market usually recovers from such episodes quickly.
Having said all that, when looking at the SPDR S&P 500 ETF Trust (SPY - 196.74) September open interest configuration, a decline below the put-heavy 195 strike this week could generate sharp selling. The next big magnets are at the 190 and 185 strikes. A move to 185 would be a worst-case scenario, while a best-case scenario is the SPY being the beneficiary of short covering related to the heavy put open interest strikes.
One way you can "rest up" during this expiration week is being prepared for explosive moves in either direction. For option buyers, that would mean having exposure to both calls and put this week.
Read more:
Indicator of the Week: Why This Survey Bodes Well for Bulls
The Week Ahead: THE September Fed Meeting