2 Reasons We May Have Just Seen a Post-Fed Top

Despite last week's rally, potential short-term resistance levels are in play for the SPDR S&P 500 ETF Trust (SPY)

Senior Vice President of Research
Mar 21, 2016 at 9:46 AM
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"The behavior of the SPDR S&P 500 ETF Trust (SPY - 202.76) in the first three months of this year continues to mirror, almost exactly, its August through October 2015 price pattern … in both October 2015 and at present, the SPY's year-to-date (YTD) breakeven was in play ($205.54 was 2015's YTD breakeven). The SPY comes into this week sitting just below its 2015 close of $203.87…Chart technicians may view Friday's rally into this potential trendline resistance as an opportunity to sell or take profits. However, if you are betting on the current pattern that we've been discussing to continue to play out, you should resist the urge to sell into this rally right now."
-- Monday Morning Outlook, March 14, 2016

The S&P 500 Index (SPX - 2,049.58) and SPDR S&P 500 ETF Trust (SPY - 204.38) price action in January through present continues to resemble that of August-October 2015. Specifically, a double-digit percentage correction was followed by a double-bottom low, and a rally of more than 10% took out resistance from multiple perspectives in both instances.

For example, in both cases, the round SPY $200 level served as a potential lid, in addition to the 80-day and 200-day moving averages.  Additionally, respective year-to-date breakeven levels in 2015 and this year came into play, as did two separate short-term trendlines that connected lower highs. 

In fact, on Thursday, the SPY rallied above its 2015 close before going ex-dividend on Friday. Meanwhile, the SPX dipped its head into positive territory for the first time in 2016 on Friday.


"Two more central bank meetings are on the agenda for this week -- the Bank of Japan and the Federal Open Market Committee (FOMC) in the U.S … it is call open interest at strikes in the immediate vicinity of the underlying SPY that could help influence stocks this week. Specifically, a positive reaction to these central bank meetings could result in a quick move to the 205 strike. The heavy call open interest here could generate incremental buying as those short the call options buy S&P futures to hedge their positions." 
-- Monday Morning Outlook, March 14, 2016

The market surged last week, despite the SPY’s 10.5% rally from the Feb. 11 lows going into last week’s trading, and the exchange-traded fund (ETF) struggling to overtake resistance early in the week. The catalyst for last week’s rally was a dovish Federal Open Market Committee (FOMC) statement, in which the Fed lowered its own projection for the magnitude of interest rate increases this year to a level more in line with market expectations.   

As we expected, the positive reaction to the FOMC led to a sharp move from Wednesday’s pre-policy statement low in the $201.50 area to the call-heavy 205 strike by late afternoon on Thursday. Needless to say, standard March-expiration SPY 205-strike calls expired worthless, as this proved to be last week’s peak.

The market tended to top out either the day of or in the immediate days following FOMC meetings in 2015. This is something to keep in mind from a couple of perspectives:

  1. If the pattern we have been discussing continues, we would expect resistance in the highs that preceded the most recent correction, which is the $207-$209 area. And if indeed a pullback occurs from this area, a retest of the SPY’s 80-day moving average in the $198 area would look very much like the two-week pullback that preceded a Fed meeting in early December.

  2. Despite last week's rally, potential short-term technical resistance levels remain in play. The SPY comes into this week trading in the vicinity of its year-to-date breakeven level, and the Russell 2000 Index (RUT - 1,101.67) is trading at the round 1,100 level -- which proved important in 2015 and earlier this year. The round 1,100 area on the RUT was supportive in August and September, while a break of 1,100 and the late-September 2015 closing low that occurred in January set in motion an additional 12.5% decline during the follow month of trading.

"The S&P 500’s move above its long-term trend line might not be as bullish as some hope. On Friday the large-cap S&P index ended above its 200-day moving average for the first time since Dec. 30, and it remained there Monday..."
-- The Wall Street Journal, March 15, 2016

"U.S. stocks have rebounded, but few investors have come to the partyStock-trading volumes have been relatively light in recent sessions … The market has climbed without much change to the fundamental picture, confounding many investors and leaving them skeptical about just how long the rally will last. Economic growth is still expected to be tepid and corporate earnings have declined for three consecutive quarters.”
-- The Wall Street Journal, March 17, 2016

With regard to bullet No. 1 above, we have reason to believe that the current price action will detach itself from the August-December price action we described above. Behind the price charts, there are differences, with one referenced last week -- how the shorts are behaving. Whereas short-covering drove the initial advance in September and October, the initial ascent from the February lows was not driven by short covering. The skepticism is in several corners, including technicians and those taking a more macro view of the market, as summed up in the excerpts above from two separate articles in the The Wall Street Journal last week.

And per the chart below, note how the equity-only, buy-to-open put/call volume ratio has turned higher. In the days ahead of the FOMC meeting, we cited this as a risk to the bullish case. But, with the FOMC meeting now behind us, and the market rallying on the news, we could see short covering becoming a supportive factor in the days and weeks ahead -- although we may stall for brief periods at resistance levels that we described above. And if pullbacks do occur, we continue to expect that they will be shallow, as our sentiment indicators are still suggesting near-extreme caution that is usually apparent when there is little downside risk in equities.     


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