VIX Positioning Points to Post-Fed Headwinds for Stocks

Buyers of the recent SPY breakout could grow impatient soon

Senior Vice President of Research
May 29, 2018 at 8:09 AM
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"Circle June 12 and June 13 on your calendar, with June 12 marking the date that President Donald Trump will meet with North Korean leader Kim Jong Un. But as much press as this meeting will receive, the meeting that could have heavier market implications is the Federal Open Market Committee (FOMC) gathering on June 13."
-- Monday Morning Outlook, May 14, 2018

"Stocks Slide After North Korea Summit Called Off"
-- CNBC TV, May 24, 2018

If you circled June 12 on your calendar, you can now erase it -- at least for now, as President Donald Trump canceled the summit with North Korean leader Kim Jong Un. As stocks slid initially in Thursday’s trading in reaction to this news, I commented to my colleagues that equities have rallied for years without a North Korean summit on the calendar. 

The implication was that Thursday’s session was likely the "usual noise" that we have seen before, including the "war of words" between President Trump and his North Korean counterpart that gave market participants jitters for a few days in mid-August 2017. Indeed, by Thursday’s close, the market rallied well off its morning lows, before giving back a little ground on Friday, heading into a long Memorial Day weekend.

"If a pullback occurs, bulls want to see support on the SPY come into play between $266.86 -- its 2017 close -- and the $270.43 level"
-- Monday Morning Outlook, May 14, 2018


The S&P 500 Index (SPX - 2,721.33) and SPDR S&P 500 ETF Trust (SPY - 272.15) traded more than 1% lower in that Thursday session, with lows at 2,707.38 and $270.78, respectively -- above the upper-end of a support zone that I discussed two weeks ago. For those of you that do not remember, SPY $270.43 was the close when the Fed last raised rates in March. It was a resistance level in between the March and early May Federal Open Market Committee (FOMC) meetings, with this resistance mark giving way in the aftermath of the Fed holding rates steady in early May. 

Moreover, the SPY $270 level corresponds with the round 2,700 century mark on the SPX. The fact that these levels were not revisited on Thursday is indicative that market participants are currently at the ready to accumulate stocks or cover short positions at the slightest hint of a pullback.

While bulls have the upper hand, the SPY has been directionally challenged since the breakout above the trendline connecting the January and March highs. When this breakout occurred on May 11, this trendline that is on the radar of many technicians was around $272, which is the site of Friday’s close. Said another way, buyers of this breakout have yet to make money and could grow impatient if the SPY does not sustain a move above $272 in the coming days and weeks.  

SPY daily chart 2018

One group that has benefited during this two weeks of trading-range behavior is index option premium sellers, as volatility, as measured by the Cboe Volatility Index (VIX - 13.22), has remained tame. 

Speaking of volatility, concurrent with the SPY and SPX’s mid-May breakout above resistance, large speculators on VIX futures moved back into a net short position, per Commitments of Traders (CoT) data. As many of you know by now, this group is an excellent contrarian indicator when in an extreme position. The group is rarely net long VIX futures, and since moving into a net long position in early February, VIX futures have declined sharply, as displayed in the chart immediately below.

CoT large VIX specs

You will also see on the chart that while large speculators are net short, they are far from an extreme short position. With that said, Schaeffer's Quantitative Analyst Chris Prybal ran a study this past week looking back at how the SPX has behaved after large speculators move out of a net long position into a more normal short position.

We looked at data since 2010, since this is when volume on VIX futures began to grow. Per the table below, the one- through four-week performance stands out as particularly bullish. However, the period beyond four weeks indicates the market tends to struggle. I found this study interesting because the four-week period after the most recent signal ends around mid-June, when the FOMC is scheduled to meet again and is widely expected to raise rates.  

The study lines up with a scenario I have discussed in prior commentaries -- the market rallies into the June FOMC meeting, but struggles in the immediate aftermath of a rate hike, like it has typically done during this tightening cycle and as we move through the summer months. 

SPX returns after CoT VIX revert

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