"Ironically, short-term market participants have turned positive on stocks just ahead of this Wednesday's FOMC meeting... note that stocks have struggled in the month after a rate hike during the current tightening cycle -- with a notable exception being December 2017, when tax cuts 'Trumped' Fed policy."
-- Monday Morning Outlook, June 11, 2018
"If past is prologue, it was the Fed's action last Wednesday that could have a negative impact on the stock market in the short term. Loyal readers are now fully aware that during the current rate-tightening cycle, equities -- as measured by the SPDR S&P 500 ETF Trust (SPY - 277.13) -- underperform or even experience a drawdown in the month following a rate hike, while showing a tendency to rally and produce respectable returns when the Fed holds steady.
"...you can expect potential resistance on the SPY over the next four weeks in the area between $278.03 and $278.92… [SPY] is trading further below resistance relative to the S&P 500 Index (SPX – 2,779.66), which is above its FOMC day close of 2,775.63 and slightly below 2,786.85, which is where it closed on the evening before last week's rate hike."
-- Monday Morning Outlook, June 18, 2018
It was another week dominated by macro headlines, such as trade tariffs going into effect in Europe, President Donald Trump threatening auto tariffs on European imports, and rumors that the Trump administration is seeking to meet with Beijing officials before U.S. trade tariffs on Chinese goods go into effect in early July. Sector headlines were also predominant, with the U.S. Supreme Court ruling that states have the right to collect taxes on internet sales, banks passing their annual stress tests, and the Organization of the Petroleum Exporting Countries (OPEC) agreeing to raise production in line with estimates. In the technology arena, cloud-computing software company Red Hat (RHT) reported earnings and guided lower for the next quarter, pushing many tech names lower on Friday.
Overall, equities -- as measured by the S&P 500 Index (SPX - 2,754.88) and SPDR S&P 500 ETF Trust (SPY - 274.74) -- began their full first week of trading after the June 13 rate hike continuing the pattern of weakness that we have observed in the month following a rate hike since December 2015. It remains to be seen if further declines or a choppy period with resistance at Fed day levels will persist over the next three weeks, but anyone reading this commentary lately cannot say they were blindsided by last week's action.
The SPX's 2,750 half-century mark proved supportive ahead of Friday's rally, which also may not come as a major surprise to loyal readers, as half-century marks on the SPX often act as support or resistance for the index. If the 2,750 half-century mark eventually gives way to sellers, the 2,730 level is the next line of potential defense, with the 2,700-2,715 area providing yet another line of support.
SPX 2,730 previously acted as resistance in May, and marked the intraday high when the Fed hiked interest rates in March. Plus, the 2,730 area is currently home to the SPX's 40-day moving average.
I see 2,700-2,715 area as important not only because 2,700 represents a round century mark, but also because this is the zone where buyers stepped in when the index broke above a trendline connecting a series of lower highs since late January. Additionally, 2,706 is quadruple the SPX bear-market closing low from March 9, 2009, and the mid-April 2018 closing high lies nearby at 2,708. Finally, the 2,715 level is where the SPX was trading on the eve of the March rate hike, and it's a level that acted as short-term resistance in mid-April.
If you are trading SPY, the 275 strike is the site of more than 150,000 weekly and standard expiration put options that expire between this Friday and standard expiration on July 20. If support at $275 breaks, I would expect the $270-$272 level to be potentially supportive for the same reasons described above for the SPX; note that $272.44 is quadruple SPY's March 9, 2009 bear market low close.
Small-caps, as measured by the Russell 2000 Index (RUT - 1,685.58), managed to carve out a new all-time high last week, moving above the 1,675-1,685 area where the index was trading on the eve of and on the day of the most recent rate hike. Like the SPY and SPX, the RUT struggled in the immediate aftermath of the March rate hike, and stalled at its Fed day closing level in April.
However, the RUT met resistance on its first-ever test of the round 1,700 mark. It is currently trading roughly 10% above the 2017 close -- a level that may tempt profit-takers who bought at the beginning of the year. Moreover, the 1,700 area represents a round 20% year-over-year return, and this will be true through early July. With these round-number percentage gains in play, small caps may face profit-taking headwinds on rallies into 1,700.
Even though round-number resistance lies immediately overhead on the RUT, I still prefer small-caps over large-caps, as -- unlike the Dow Jones Industrial Average (DJI - 24,580.89) and SPX -- small-caps ventured into new-high territory last week, and thus face less chart resistance. Moreover, short interest on RUT components is rolling over after a build in recent months, and this short-covering activity could be supportive if it continues. In fact, total short interest on RUT components peaked as recently as July 2017, and remains far above the levels of 2014, per the chart immediately below.
I have not discussed volatility in some time, so I thought it might be worthwhile to point out that a chunk of CBOE Volatility Index (VIX - 13.77) call options expired worthless last week. With the "wrong-way" large speculators on VIX futures moving back into a net short position in mid-May, per Commitments of Traders (CoT) data, and increasing this net short position steadily since that period, the risk of a post-expiration VIX pop increases slightly, as those no longer hedged for a volatility pop are more apt to cover a short VIX futures position if a negative headline emerges in the immediate days ahead. The VIX is currently situated between potential support at 12.43 -- half the March closing high when trade tensions began -- and 16.04, its closing high in August 2017 when tensions with North Korea heightened in a "war of words" between President Trump and Kim Jong-Un.
Avoid big bank stocks such as JPMorgan Chase (JPM), as many talking heads in the media are touting these names as the Fed raises rates and they trade down to their 200-day moving averages. And expect stocks to remain in the doldrums for at least the next few weeks. With inflows of $3.4 billion into the SPY since the Fed's rate hike last week, and the all-equity, buy-to-open put/call volume ratio turning lower from an already low level, optimism among short-term traders on the heels of the June 13 rate hike still presents a risk to short-term bulls. In fact, the equity put/call volume ratio is now around the levels that preceded the correction earlier this year (see graph below).
Traders with shorter time frames should have a healthy mix of bullish and bearish positions in their portfolio to address the current short-term risks.
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