Why Sideways Price Action Is a Win for Bulls Right Now

Stocks have struggled to extend their post-election gains as short selling activity ramps up again

Senior Vice President of Research
Apr 3, 2017 at 8:32 AM
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"... last week's action pushed the [SPX] to its 40-day moving average -- which, coincidentally, is the vicinity of the 2,350 half-century mark. Since July, this trendline has acted as both support and resistance, with crosses above and below the moving average acting as reliable bull and bear signals, respectively... 

"...SPX half-century marks have tended to act as key pivot points or 'magnetic' levels historically, with the 2,350 half-century mark being no different... it is likely that sideways movement grips the market over the next few weeks...

"...the RUT is trading slightly below its 2016 close of 1,357.13. But it too comes into this week at potential support from its 100-day moving average, which is just a couple of points below the 1,350 half-century mark and this year's January closing low of 1,345.75."

    -- Monday Morning Outlook, March 27, 2017

If you are focused only on the S&P 500 Index (SPX - 2,362.72) chart and/or intraday action of other indexes, last Monday morning's sell-off could have easily tripped a bearish signal for stocks, and maybe a bullish signal for volatility. For example, the SPX closed below its 40-day moving average, a trendline that I mentioned as flashing reliable bull and bear signals since July.

Meanwhile, the CBOE Volatility Index (VIX - 12.37) popped intraday above its December resistance levels, which coincides with the year-end 2016 close of 14.04. But the VIX ended the day at 12.50 -- significantly below the resistance taken out earlier in the morning. By Thursday, the VIX hit 11.25 again, half the pre-election closing high. As discussed last week, stocks have struggled after VIX touches of 11.25 since December.

vix daily chart 0331

Moreover, the VelocityShares Daily Inverse VIX Short-Term ETN (XIV - 73.03) pulled back to -- but never breached -- the 66 level, which is double its November closing low. I mentioned the pullback to 66 on Twitter on Monday morning, and the fact that this level held as the VIX popped above resistance was perhaps indicative that volatility had peaked in the short term. In fact, by Monday's close, the XIV was again more than 50% above its 2016 close -- a round year-to-date return that marked an XIV peak in mid-February.

Turning back to a key equity benchmark, this year's lagging Russell 2000 Index (RUT - 1,385.92) fell intraday below its 100-day moving average, but closed above this trendline, as it continued to find support around its 2016 close at 1,357. But the RUT comes into this week a round 20% above the November 2016 low, which has acted as resistance on multiple occasions, and the round 1,400 century mark lingers just above, too.

rut daily price chart 100-day moving average 0331

Furthermore, the SPX crossed back above the 2,350 level after the false bearish cross below its 40-day moving average. I have been cautioning that 2,350 could prove to be a magnetic force, much like 2,250 was in December.

So far, this magnetic effect is indeed in place, as the SPX price action is somewhat like December. In both cases, following a mid-month rate hike, the index is struggling to find direction, with half-century marks (at 2,250 and 2,350, respectively) acting as magnets.

spx daily 60-day moving average 0331

"... after four consecutive months of advances, if the SPX closes below 2,363 on Friday, it will be the first losing month since October. The 2,363 level is just 1 point below strategists' average year-end forecast of 2,364, making this an important level to watch in the coming week."
    -- Monday Morning Outlook, March 27, 2017

I find it interesting that just as the SPX battled to hold support at the beginning of the week, it battled to overtake a potential resistance level that I pointed out coming into the week. After trading above the 2,363-2,364 level for much of the day on Friday, the SPX closed below the 2,363 level, which was the March breakeven point.

"For The Trump Trade To Survive, Markets Need Some Results"
    -- Forbes, March 29, 2017

"These Trump Trades Just Aren't Working Anymore"
    -- The Wall Street Journal, March 30, 2017

"Risks to Rally, Trump Trade in Trouble"
    -- CNBC television headline, March 31, 2017

"Bearish Hedge Funds Stand to Gain as Trump Rally Fizzles"
    -- The Wall Street Journal, March 31, 2017

"The Trump Presidency Is In A Hole"
    -- The Economist cover story, April 1, 2017

From a sentiment perspective, and as noted in the various headlines last week, skepticism is growing with regards to the "Trump Trade." It is very tempting to buy into the doubt, as many market experts were predicting a sharp correction in stocks if Donald Trump was elected president. But instead of getting a 10% correction, the SPX is more than 10% above its Election Day close of 2,139, with an all-time closing high occurring on March 1 at 2,395.

"... hedge-fund managers have grown concerned that central bank stimulus has pushed stock prices too high, and that prices remain elevated despite a recent correction. That leaves stocks vulnerable to political risks in Europe, such as Brexit or elections across Europe, or rising U.S. interest rates."
    -- The Wall Street Journal, "Bearish Hedge Funds Stand to gain as Trump Rally Fizzles," March 31, 2017

"... those seeking sanctuary from lofty stock valuations are gravitating toward Europe for cheaper bargains as the trade matures. Strategists at Deutsche Bank AG urged investors this week to cut holdings in U.S. stocks in favor of the region's shares, along with BlackRock Inc.... a net 23 percent of global fund managers believe European stocks are undervalued, compared with 81 percent who think U.S. equities are too pricey -- the largest expression of valuation fears in more than 20 years."
    -- Bloomberg, March 30, 2017

Trump administration policies and the "Trump trade" fading aren't the only worries among market participants, as the prospect of higher interest rates and uncertainty in Europe (with respect to the upcoming elections in France and "Brexit") are front and center, too. U.S. stock valuations are also a concern among fund managers -- who appear to embrace valuations in Europe, despite the political uncertainty in that same region that is keeping investors out of the U.S. market. I'll let you make sense of that rationale; my head is spinning!

Nonetheless, short interest on SPX components has clearly risen during the past few reports. One on hand, this is favorable to bulls, as it confirms the growing caution and lower expectations that have gripped the market over the past few weeks. On the other hand, stocks have struggled as the shorts have come back into play, after a period in which short covering helped drive a sharp rally from the pre-election lows.

spx stocks short interest 0331

In the absence of short covering, any advances in the market could be slow and laborious. A "victory" for bulls would be continued sideways movement as growing caution prevails. Such caution eventually sets up positive surprises in the future.

The biggest risk is what I've been discussing for weeks: large speculators continue to be in an extreme short position on VIX futures, per the latest Commitments of Traders (CoT) report. This is a group that is historically wrong at major turns in volatility, so we continue to advocate using call options to reduce your dollars at risk while at the same time being on the side of the prevailing trend.

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