Stop Sweating the S&P 50-Day

September, the cruelest month for stocks, is right around the corner

Senior Vice President of Research
Aug 28, 2017 at 8:38 AM
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 "...a confluence of worrisome signals suggest that the market could be setting up for a pullback. Exhibit 1 is the 50-day moving average of the S&P 500, a short-term yardstick used by technical analysts to track trading momentum. The benchmark failed to hold above this measure on Wednesday and on Thursday..."
    -- The Wall Street Journal, August 25, 2017

"Hours after U.S. Secretary of State Rex Tillerson praised him for exercising restraint, North Korean leader Kim Jong Un appeared in state media visiting a missile-development factory and ordering the production of more warheads and rocket engines. Mr. Kim's visit, the date of which wasn't disclosed by Pyongyang in its report Wednesday, underscores North Korea's continued investment in its ability to threaten the continental U.S. with a nuclear-tipped long-range missile."
    -- The Wall Street Journal, August 23, 2017

"A Treasury bill due Oct. 12 has a higher yield than one that matures Nov. 24 -- unusual for fixed-income securities which typically yield more for longer maturities. That deviation from the norm suggests investors are worried Washington may fail, and yields are rising to compensate for the risk that investors due their money in October won't be paid on time... Lawmakers would have to deal with both [raising the debt ceiling and avoiding government shutdown] in relatively short order ..."
    -- The Wall Street Journal, August 25, 2017

In last week's commentary, I pointed out that multiple equity benchmarks were trading around potential key support levels. After a feeble bounce from these support levels, I found the excerpt related to the S&P 500 Index (SPX - 2,443.05) 50-day moving average on Friday of interest, as a testament to the popularity of this trendline among some technicians. While the 50-day moving average has acted as support on various occasions this year, so too has the 80-day moving average during those times the 50-day did not.

Therefore, I continue to focus on the 80-day moving averages on the PowerShares QQQ Trust (QQQ - 141.97) and SPDR S&P 500 ETF (SPY - 244.56) as guideposts for what may lie immediately ahead for the stock market. Moreover, the iShares Russell 2000 ETF's (IWM - 136.88) 2016 close of $134.85 is on my radar.

The last time the SPY, SPX, and QQQ closed significantly below their 80-day moving averages after spending multiple days above them was Oct. 11, 2016. Weakness prevailed into early November as election uncertainty lingered.

And so the 80-day moving average remains my point of focus, as a break of this trendline could lead to additional weakness as a mountain of uncertainties related to North Korea, tax reform, the debt ceiling, and a possible government shutdown continue to fester, just as election uncertainty was predominant in October 2016.    

Above said, even though a bounce in equities occurred last week, there is more to be done in order for the short-term technical backdrop to inflict pain on the bears. The IWM, for example, is trading just below its 200-day moving average, which acted as support in early November 2016. Additionally, it is still below the $138 level, which has acted as resistance on multiple occasions (December 2016; January, March, and April 2017).

Furthermore, the last time the SPY went a month or longer without rallying above its Fed-day close in the absence of a rate hike was September 2016. With that said, it has now been just over a month since the July 26 Federal Open Market Committee (FOMC) policy decision. The Fed did not raise rates, but the SPY has not yet rallied above the July 26 close of $247.43. In fact, since mid-August, the SPY has spent much of its time trading around the June 14 close of $244.24, which is when the Fed last raised its benchmark rate. Unfortunately for bulls, interviews with Fed governors and a Friday speech by Fed Chair Janet Yellen at a gathering of world central bankers in Jackson Hole, Wyoming, could not move the SPY needle.

Also, the SPY enters this week just below $245.88, which is a round 10% above last year's close. Since the SPY first touched the 10% year-to-date level in mid-July, it has been a frustrating sideways grind for bulls and bears alike.

"...if volatility retreats in the short term, look for the [VIX] 11.25 level -- half the pre-election closing high -- to be supportive. I expect that retreats in volatility will be viewed as a good opportunity to buy protective puts on equity index options and/or cover short volatility positions."
    -- Monday Morning Outlook, August 14, 2017

The CBOE Volatility Index (VIX - 11.28) was declining from 2017 resistance in the 16-17 area as we entered last week's trading. So, it was not a major surprise when volatility eased further as equity indexes moved higher from support. The VIX retreated to 11.46 from the prior week's close at 14.26.

And for the second consecutive week, the VIX found a floor in the 11.25 zone -- a support area in March, when equities struggled under the weight of a Fed rate hike. The 11.25 level is one that I pinpointed two weeks ago as a prospective support level, as market participants might be more eager to hedge long portfolios amid growing uncertainties with respect to North Korea.

vix 10 minute chart since aug 14

Therefore, if one is anchoring to the pre-election high of 22.51, a VIX reading that is half that level might be viewed as an attractive entry point to buy portfolio protection via SPX or SPY put options. With the recent terrorist attack in Spain, debt ceiling/government shutdown worries now mounting, and tax reform back in the headlines, some market participants may use last week's retreat in volatility as an opportunity to stock up on portfolio insurance. Such activity has the potential to create a short-term headwind as we close August and move into September, which is historically the weakest month for stocks.

spx returns by month 0825


"Credit Suisse Tells Clients to Take Stock Gains, Breathe, Hedge"
    -- Bloomberg, August 19, 2017

"Wall Street Banks Warn Downturn Is Coming... HSBC, Citigroup, Morgan Stanley say end of market boom is nigh"

    -- Bloomberg, August 22, 2017

"U.S. equity funds suffered their longest streak of outflows in 13 years as growing signs of political deadlock in Washington cast doubt on a rally that has taken the S&P 500 Index to record highs...Investors pulled $2.6 billion from U.S. stock funds in a 10th consecutive week of outflows, Bank of America Merrill Lynch said in a research report citing EPFR Global data. That takes total outflows since late June to $30 billion, according to the report, which covered the week to Aug. 23."
    -- Bloomberg, August 25, 2017

For bulls, there is a silver lining when looking through the lens of a contrarian investor.
We have been inundated with headlines that have distracted investors -- everything from dysfunction in Washington, D.C., to terrorist attacks and nuclear threats, plus endless uncertainties with the Fed (who will be the next Fed chairman?  Will the Fed raise rates again by year end?  When will the Fed begin reducing the assets on its balance sheet?  How will this impact stocks and bonds?). Meanwhile, technicians have voiced concerns ranging from deteriorating internals to poor earnings reactions potentially signaling weakness ahead.

Add it up and you have some pessimistic sentiment extremes on the radar. However, the price action in broader indexes, such as the SPX, is not validating such extremes in sentiment as we are seeing among Wall Street strategists, mutual fund investors, and equity option speculators. For example, the SPX achieved an all-time high last month and is only 1.7% below its all-time closing high. This disconnect between sentiment and price action should bode well for bulls going forward, even as investors are constantly reminded of the prevailing risks. Patience will reward bulls, and pullbacks should continue to be bought.

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