Pessimism continues to linger, despite the market's advance off its February lows
"The market tended to top out either the day of or in the immediate days following FOMC meetings in 2015 …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."
-- Monday Morning Outlook, March 21, 2016
Stocks
took a breather last week -- which wasn’t a huge surprise, with short-term technical resistance in play and only days removed from the March Federal Open Market Committee (FOMC) meeting. Two Fed members -- one a voting member of the FOMC -- hinted at a possible rate hike as early as the next meeting, and this was enough to drive stocks lower late in the week.
With the SPDR S&P 500 ETF Trust (SPY - 203.12) trading in the vicinity of its 2015 close for the first time this year, a key expected volatility measure -- the CBOE Volatility Index (VIX - 14.74) -- situated at one-half last month's closing high, and hawkish "Fed speak" emerging, sellers dominated. Possibly adding to the selling pressure was an unwinding of long positions associated with the "call wall" at the SPY 205 strike on options that expired or are about to expire this week.
Specifically, when adding up the call open interest at the 205 strike on options that expired last Thursday or about to expire in this week's "double" expiration -- quarterly SPY options expire on Thursday, while weekly SPY options expire on Friday -- this call wall is evident, as seen on the graph immediately below. As you can see, the SPY traded sideways for a short period at the call wall, before finally giving way to sellers late in the week.
SPY call open interest -- 3/24, 3/31 quarterly and 4/1 weekly expirations
"…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."
-- Monday Morning Outlook, March 21, 2016
"The investor money that's flowed into VIX-linked products over the past month has amounted to $3.5 billion in bets that VIX futures will rise, according to Nick Cherney, head of exchange-traded products for Janus Capital Group. That's a record amount..."
-- The Wall Street Journal, March 24, 2016
In addition to the many observations I have made about the current SPY pattern resembling the SPY's behavior in the August-November 2015 period, I have also pointed out the pessimism that continues to greet the advance from the February lows. It is the pessimism that looms that makes the present rally from the February lows different from the September-November double-digit percentage advance.
For example, there was not short-covering in the initial rally from the February bottom, whereas short covering occurred early off the September 2015 bottom. Moreover, sentiment among equity option buyers remains relatively skeptical at this juncture in the rally, albeit not as pessimistic as we witnessed at the February lows.
With the above said, two other sentiment data points are intriguing. First, large speculator VIX futures players remain in a net long position, according to the weekly Commitment of Traders (CoT) report. This suggests expectations among this group that volatility will rise amid declining stock prices.
It is rare for this group to be net long VIX futures, as you can see in the five-year chart immediately below. Moreover, it is often that these players prove to be excellent contrarian indicators. The large speculators -- who some say represent hedge funds -- have been net long since mid-January, despite VIX futures plummeting during this period. Currently, this group is reducing its net long position, but there is a lot of capitulation potential in this group that could drive volatility lower and stocks higher.
CoT Report -- Large speculators' net positions on VIX futures
Another sentiment indicator that we find intriguing for bulls in the weekly CoT report is the net positioning of large speculators on S&P 500 Index (SPX - 2,035.94) futures. Per the chart below, note that this group was net short earlier in the month, and has since moved into a net long position -- though the long exposure is historically low. When this group has been net short in the past, the market has hit major bottoms and went on to rally impressively as short positions are closed and these players chase the rally. If these players increase their long exposure in the weeks ahead, as they remain underweight, such actions could produce a powerful bid for equities.
CoT Report -- Large speculators' net positions on SPX futures
"GLD hit $120 -- a round level 20% above its recent low at $100 and site of its 36-month moving average, which marked an important bottom in 2008. A monthly close below this trendline in April 2013 hinted at more troubles ahead. Last week's touch of this moving average is the first since early 2013, and the jury is still out as to whether this marks the end of the GLD rally in 2016 or not. So, if you are thinking about getting long GLD, perhaps best to wait for a monthly close or significant close above $120."
-- Monday Morning Outlook, February 16, 2016
Finally, as we enter the last trading week of March, we thought a follow-up on last month's comments on gold is in order, specifically with respect to the SPDR Gold Trust ETF (GLD - 116.33). In February, we noted the huge rally in the precious metal, but speculated that it might be good to hold off on buying gold, as long-term resistance from its 36-month (3-year) moving average was just overhead.
When using longer-term charts like this, long-time readers know that we emphasize monthly closes. GLD popped over its 36-month moving average intra-month, but after last week's sell-off, it enters the last week of March below this important trendline that marked a key low in 2008.
The declining 36-month moving average is now at $118.48, so we still advise a monthly close above this trendline to confirm that a change in the longer-term trend is probable. Another option for you is to buy a pullback to the $114 area, which gives you more breathing room to resistance in the $118.50-$120 area. The $114 area is the site of a trendline connecting lower highs since early 2014, which GLD broke above last month.
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