The Similarities to 2011 Go Beyond the Charts

A consolidation could be in order, as major benchmarks trade near key levels

Senior Vice President of Research
Oct 12, 2015 at 9:26 AM
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"… 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."

-- Monday Morning Outlook, September 28, 2015




During the last few weeks, I have discussed conflicts we are seeing in the market -- including extremes in pessimism typically seen at market bottoms, accompanied by a technical backdrop that might be described as warranting such negative sentiment. But even in describing the technical backdrop, it has been murky, as two consecutive S&P 500 Index (SPX - 2,014.89) closes below its 20-month moving average has historically meant tough times ahead, yet the pattern of 2015 was remarkably similar to 2011, with the implications being a major bottom in October.

The Friday, Oct. 2, key reversal day on the SPX continued the "similar to 2011" theme, as the first week of October 2011 also featured a day in which the SPX was down more than 1% during the day, only to finish higher by more than 1%. Moreover, in digging further into the likeness to 2011, per the tweets immediately below, technology -- measured by the PowerShares QQQ Trust (QQQ - 106.53) -- and small-caps -- per the Russell 2000 Index (RUT - 1,165.36) -- bottomed last week at long-term moving averages that also supported the major trough in September/October 2011.





The similarities to 2011 do not stop on the charts. Out of curiosity, I referred back to my 2011 market files, particularly with respect to the Federal Reserve, as recently released dovish Federal Open Market Committee (FOMC) minutes were supposedly the impetus for Thursday's rally, following a weaker-than-expected employment report on Friday that was accompanied by a hawkish reaction by San Francisco Fed President John Williams. 

Regardless of whether or not the market is responding to dovish or hawkish indications by the Fed, I found it interesting that the Bernanke-led Fed in the fall of 2011 had very similar views to the Yellen-led Fed of 2015. In italics below is a 2011 summary of the FOMC’s thoughts, with my highlights displaying the similarities to today:


Wednesday, September 21, 2011 2:41:54 PM ET

Economy: Sept 21 -- economic growth so far this year has been considerably slower than the Committee had expected.

Labor conditions downgraded: Sept 21 -- Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated...

Remains the same -- Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable...

Uptick in Economic Outlook as it sees a recovery: Aug 9 -- The Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting and anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate... Sept 21 -- The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.

Adds in 'significant' to downside risk:  Aug 9 -- Moreover, downside risks to the economic outlook have increased. ... Aug 9 -- Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets...


Specifically, the Fed in 2011 was:

  • Overly optimistic in their economic projections
  • Concerned about declining commodity prices and global financial market strains
  • Data dependent

Sound familiar? Other than the outlook on the labor market, the Fed today sounds much like that of 2011, as it deals with similar conditions. The uncertainties now were also present in 2011, and in both cases they were enough to generate corrections in our equity market. 

Such Fed uncertainty and jitters over world markets were not enough to knock U.S. stocks off course from a longer-term perspective in 2011. Now, with the SPX back above 2,000 and the CBOE Volatility Index (VIX - 17.08) back below its floor in the 19.20-20.37 area following a VIX/SPX divergence similar to the 2009 bottom (discussed last week), it appears similar uncertainties may not be enough to knock the current bull off course. 

There is also the potential that this current extreme in negative sentiment that we've highlighted begins to unwind, albeit slowly, as benchmarks contend with overhead shorter-term resistance levels. In fact, short interest on SPX component stocks spiked higher by 14% in the month of September. With the SPX trading mostly in the 1,950 area and ranging between 1,880 and 1,980, there is a good possibility that these recently added positions are underwater, setting up a squeeze situation.

SPX component short interest spiked higher by 14% in September



Turning to the short-term outlook, while the RUT has rallied off of long-term support, there is potential short-term resistance overhead. Specifically, the 1,165 area could be a hesitation point, with this level: 1) 10% below the 2015 closing high in June; 2) the site of the 50-day moving average; 3) a 38.2% Fibonacci retracement of the June high and late-September low; and 4) the site of its January 2015 closing low.   

Moreover, with benchmarks such as the Dow Jones Industrial Average (DJIA - 17,084.49) and the SPX sharply rallying through round millennium levels at 17,000 and 2,000, respectively, and the QQQ trading just below its 80-day moving average (mid-September peak), a consolidation could be in order, as potential buyers or those looking to unwind a short position take a "wait and see" approach. 

With a bank holiday today and the economic calendar light into Friday, trading may be thin, except for companies reporting earnings. Don't forget, however, that standard October equity and index options expire this Friday, and trading may also be influenced by expiration of these options (VIX options expire Wednesday, Oct. 21).

As we usually do, we'll look at the SPDR S&P 500 ETF Trust (SPY - 201.33) open interest configuration to discuss a possibility for the next week. What stands out is the big put open interest far beneath the current market price. It is possible that the sharpness of the recent rally was helped along by the unwinding of short positions related to this put open interest, as the deltas -- or sensitivity of these options to SPY movement -- decreased as the SPY moved further above the strikes and we moved closer to expiration. This would argue again for a consolidation to the extent that short covering may not be as great. 

Moreover, with huge call and put open interest at the 200 strike, there could be an incentive to pin the SPY around this level on expiration Friday, allowing sellers of put and call options to pocket the premium received. A close around $200 would mean a huge number of call and put options expire worthless. We would expect to see a decline supported at the 198 strike, where put open interest exceeds call open interest by a wide margin. This strike is also the site of the SPY's December 2014 and January 2015 lows. A rally could find resistance in the 203 area, home to the SPY's 80-day moving average, and where call open interest dwarfs put open interest.





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