The SPY Pattern You Must Watch in October

There are striking similarities between recent market action and the sell-off we witnessed in 2011

by Todd Salamone

Published on Sep 28, 2015 at 9:26 AM
Updated on Sep 28, 2015 at 11:12 AM

As some of you may recall, we observed a few weeks ago that the S&P 500 Index (SPX - 1,931.34) closed below its 20-month moving average, a trendline that we follow closely given its importance historically. After publishing quantified data related to monthly closes below this moving average shortly after this technical breakdown -- after 12 consecutive monthly closes above it -- one of our conclusions was: "heightened risk of a weak market 12 months out, but this is far from a slam-dunk."

We continued by saying:

"… [W]e found that how the following month plays out could be an indication of how the next 11 months play out. Specifically, when the SPX was flat to negative (up less than 0.49%) a month after the signal, its 12-month return was negative five out of seven times. But if the SPX was higher by 1% or more one month after its first monthly close below the 20-month moving average, it was higher 12 months later in all four instances: all double-digit returns, three returns in excess of 20%."

- Monday Morning Outlook, September, 8, 2015

With the SPX closing at 1,972 last month, history would suggest that an SPX close back above 1,991, or 1% above the August close, would greatly improve the longer-term stock market outlook, especially within the context of a sentiment backdrop that is more than conducive to powerful market advances. With the month-end close occurring this Wednesday, bulls would like to see a strong finish to this month.

$SPY '15 rectangle and decline to 3-yr MA (156 wks) in mid-Aug similar to 2011 ? If so, look for mid-Oct low $SPX pic.twitter.com/g90K4pghGa

Regardless of what occurs at month's end, there is another angle that one can take in determining whether or not the market is in bear mode, or simply carving out a basing pattern following its correction. Per the observation immediately above on Twitter last week, I observed how remarkably alike the SPDR S&P 500 ETF Trust (SPY - 192.85) price action is to 2011, when the market last corrected, bottoming in mid-October of that year.

In both instances, a "rectangular" formation occurred at multi-year highs over a long period of time before the correction occurred. Even more amazing, the "rectangle" formation began in 2011 at a price point where the SPY had doubled its 2009 low. Likewise, in May 2015, the SPY doubled its October 2011 low, at which point the grueling trading range began.

And in both years, the meat of the correction began in August, with key short-term bottoms occurring in August, too. The SPY's 156-week moving average, which is equal to a three-year moving average, proved supportive in August 2011 and August 2015.

The commonality does not stop there, as a short-term advance from this long-term trendline peaked three weeks after the initial trough at the 80-week moving average. In both cases, there was an "intra-week" move above the 80-week moving average before a weekly close back below it signaled a short-term selloff, which we witnessed last week.

As Mark Twain said, and something that's commonly heard on Wall Street, "History doesn't repeat itself, but it does rhyme." In 2011, the SPY barely moved below its mid-August low in mid-October, before a powerful rally emerged with small pullbacks along the way. In fact, the next 10% correction from this bottom finally occurred recently, after SPY had doubled from the mid-October 2011 low.

150928SPY1

In 2011, SPX finished more than 10% higher the month after closing below its 20-month moving average. In fact, it closed back above its 20-month moving average the following month. Unless the SPX rallies back above its 20-month moving average at 1,999 by Wednesday's close, history will not repeat itself. But, a further decline into mid-October that successfully tests the August lows would certainly have a "rhyme" to it. This is a scenario that longer-term investors should remain open to, even with the growing possibility of a negative September and another close below its 20-month moving average that heightens the risk of weaker market longer-term.

 "… [V]olatility watchers should be prepared for higher volatility, post-Fed and with the failures at longer-term resistance last week…From a potential support perspective, short-term traders should focus on the 1,917 area, as this level is 10% below the 2015 closing high, and has marked this month's lows … the CBOE Volatility Index (VIX - 22.16) experienced a 'head fake' move below 'half-high' support in the 20 area, before rebounding strongly Thursday afternoon from its July peak. Therefore, with Fed uncertainty and the market failing at the technical levels discussed above, a VIX move back above 23.90 would likely mean higher volatility in the immediate days ahead. In fact, at this point, another yard marker to look for with respect to a more bullish environment for stocks might be a VIX close below 19.20 -- its 2014 close."

Monday Morning Outlook, September 21, 2015

$DJIA round-number support at 16k yesterday, $MID round-number resistance at 1,400 today?


$VIX pop this week after the move below 20.37 ('15 half closing high). Decline followed move above 23.90 (double '15 closing low) $SPX


As anticipated, we saw volatility pop last week. In fact, the CBOE Volatility Index (VIX - 23.62) hit an intraday high of 25.30 on Thursday, coincident with the SPX pulling back to our anticipated level of short-term support -- 10% below this year's closing high in the 1,917 area. Eventually, the VIX would settle on Thursday back below the 23.90 area that we've been monitoring. The VIX levels described in the above tweet, in addition to 19.20 -- last year's close -- are levels that we continue to view as significant, if you are looking for clues as to the future direction of the VIX. Right now, it is in the middle of these key potential support/resistance levels.

When the SPX found its weekly trough on Thursday, the Dow Jones Industrial Average (DJIA - 16,314.67) made its low just above the round number 16,000 level. And on Friday, the S&P 400 MidCap Index (MID - 1,388.21) stalled at the round 1,400 level, after bottoming at 1,376 the previous day. And following on a theme long ago about half-century marks being important on the SPX, this index stalled at 1,950 on Friday. As such, the 1,910-1,920 zone and 1,950 area on the SPX are potential pivot points in the week ahead.

We continue to see strong potential for increased volatility into October, especially with the threat of another government shutdown looming and uncertainty with respect to the next House Speaker, after Friday's surprise resignation of John Boehner (R-OH), effective at the end of October. And with Fed Chair Janet Yellen trying to offer more clarity on Fed policy on Thursday evening, the market was unable to hold onto a Friday morning rally in response. Continue to maintain exposure to explosive moves in both directions, as the jury is still out as to whether we are building a base after a correction, or in a bear market.

15092830minSPX


Read more: 

Indicator of the Week: Are Low-Priced or High-Priced Stocks The Better Bet? 

The Week Ahead: Payrolls Highlight a Week Heavy On Fed-Speak

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