4 Charts Showing Fear on Wall Street

Equity indexes are still doing battle with key round numbers

Senior Vice President of Research
Feb 26, 2018 at 8:42 AM
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"... whereas the SPX was coming off long-term support from its 200-day moving average and the VIX was situated just below potential resistance from half its 2018 high and double last year's peak, these two indexes now come into this week nearer potential resistance and support, respectively.

"For instance, the SPX high last week was around the half-century mark of 2,750, which coincides with its 20-day moving average -- a trendline it had closed below only once since late August 2017 before the 'volatility event' earlier this month sent stocks spiraling lower. Additionally, for Fibonacci followers, the 2,743 level represents a 61.8% Fibonacci retracement of its late-January high and February low.

"On a side note, the Russell 2000 Index (RUT - 1,543.55) comes into the week trading just below the half-century 1,550 level, which was resistance in November and December and is also the site of its 40-day moving average, which acted as support in mid-December. Furthermore, the S&P MidCap 400 Index (MID - 1,901.19) comes into the week at the round 1,900 century mark -- resistance in December, and site of its 20-day moving average."

    -- Monday Morning Outlook, February 20, 2018

For bulls last week, it was a good news/bad news story in terms of price action. Beginning with the bad news, equity indexes -- including the S&P 500 Index (SPX - 2,747.30), Russell 2000 Index (RUT - 1,549.19), and S&P MidCap 400 Index (MID - 1,904.23) -- did not follow through on the prior week's rally. These benchmarks came into the week trading at resistance, as described in the above excerpt. In fact, the shortened trading week began with stocks drifting mildly lower, with most rally attempts being turned away at their respective weekly breakeven points -- that is, until late afternoon on Friday.

In the final hour of trading for the week, the SPX finally moved above both its 20-day moving average and the prior week's close -- which was ironic, as the late-day weakness in the days prior received much attention and stoked fear in many market participants. The SPX remains below the 2,750 half-century mark, while the RUT comes into the week below resistance at 1,550, and the MID remains in a battle with the 1,900 century mark.

The good news for bulls is that the selling pressure overhead did not come close to matching the buying surge when equity indexes were trading at support two weeks ago. Although I didn't see any data supporting this, Bloomberg Television was reporting that hedge funds were sellers, while corporations were buyers. Whoever it was doing the buying, it was noticeable that support came in at the SPX 2,700 millennium mark, which is also coincident with a 50% retracement of the late-January peak and this month's low.

spx 20-day, 160-day, and fib levels

"... on my radar is the VIX, which after making an intraday move below the 18.30-18.66 area -- double the 2018 closing low and half this year's closing high -- closed back above this level on Friday. If you are a short-term trader, beware that the rally could take a pause as the various indexes negotiate the levels discussed above."
    -- Monday Morning Outlook, February 20, 2018

The Cboe Volatility Index (VIX - 16.49) experienced intraday moves below the important 18.30-18.66 area on Wednesday and Thursday, only to close back above these levels. Uncertainty lingered with respect to the Federal Reserve, as the transcript of Fed Chairman Jerome Powell's semi-annual Congressional testimony was to be released Friday morning. After the release of the transcript, the VIX dropped below the chart region referenced above and stayed there into the close.

This marks a potential buy signal for investors, as volatility continues to drift lower even as the historically "wrong-way" large speculators tracked by the weekly Commitments of Traders (CoT) report came into last week once again with a rare net long position on VIX futures. If volatility continues to retreat, equity indexes will likely experience a coincident drift higher in the days ahead.

Turning this discussion back to the stock market, there is debate on whether equities will revisit this month's lows. This is certainly a possibility if the major equity benchmarks remain below resistance.

However, the short-term sentiment backdrop has changed quite a bit from the optimism that was present ahead of the correction that began in late January, suggesting an increasing probability that a breakout occurs. Whether it is the VIX futures term structure in backwardation (a sign of fear), evidence of hedge fund nervousness about U.S. stocks in recent fund flows and the CoT reports, the heightened equity put/call volume ratio, or investment advisors reducing stock allocations, it is apparent that there is plenty of sideline money or short-covering potential to push equities above resistance.

For example, if indeed hedge funds are predominant in the exchange-traded fund (ETF) market, data courtesy of etf.com supports Bloomberg's assertion that they were net sellers last week. Note in the table below that there were net redemptions in the SPDR S&P 500 ETF Trust (SPY - 274.71), SPDR Dow Jones Industrial Average ETF Trust (DIA - 252.91) and iShares Russell 2000 ETF (IWM - 153.98).

big equity fund outflows last week

The "large speculators" in the weekly CoT reports are typically hedge funds -- and note the huge short position in S&P futures is almost on par with that of January 2017, which eventually preceded an impressive rally.

cot large spec net short spx futures

Gloomy sentiment among equity option buyers and investment managers is clearly evident, too. In fact, the weekly National Association of Active Investment Managers (NAAIM) Exposure Index is at its lowest level since the election in November 2016. Additionally, the equity-only, buy-to-open put/call volume ratio is rolling over from its highest level since October/November, which also preceded a period of strength in equities.

naaim number at 15-month low

equity option buyer put-call ratio feb 2018

With the long-term trend in the market still not broken, despite the recent correction, and the short-term sentiment backdrop pointing to room for improvement, there appears to be sufficient reward for bulls in exchange for the risk involved in taking on long positions with resistance lingering just above. That risk grows, however, if the VIX closes back above 18.30-18.66.

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