This Market's Most Intriguing Chart Struggle

Stocks successfully tested support, but major equity indexes are still facing some key resistance levels

Senior Vice President of Research
Aug 20, 2018 at 8:45 AM
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The U.S. equity market remains in a sweet spot, despite negative headlines early last week that pushed stocks lower, albeit only briefly. Weakness in the Turkish lira and a negative earnings reaction from Chinese Internet company Tencent Holdings were enough to push the SPDR S&P 500 ETF Trust (SPY - 285.06) down to an area of important support.

Specifically, the SPY successfully tested the put-heavy 280-strike, which corresponds to the round 2,800 century mark on the S&P 500 Index (SPX - 2,850.13). Moreover, the SPY retreated below its Aug. 1 close of $280.86 on an intraday basis, but never closed below this level. And after Thursday's strong advance from support, the SPY remains on target to register another gain in the month following a Federal Open Market Committee (FOMC) decision to hold rates steady.

Also, the SPY pullback was held in check by its 30-day moving average -- similar to late May, when a pullback to this trendline was contained not long after the Fed's decision to hold rates steady. That pullback was followed by an impressive three-week rally that was eventually halted, ironically, at $280, which is now support.

spy 30-day moving average 0817

"...something that has grabbed my attention when listening to a long line of guests on financial television during the past few weeks is the near-consensus opinion that earnings will drag stocks out of their recent funk. The thinking in this group is that investors will get back to focusing more on company-specific fundamentals, and less on the macro issues that have been holding the market back."
-- Monday Morning Outlook, April 16, 2018

"Upbeat reports by corporate America may not be enough to cheer investors dispirited by an escalating trade clash between the world's two largest economies that imperils market access."
-- Bloomberg, July 10, 2018

For what it's worth, earnings reactions have had a net positive influence on the market in the past few weeks, even though the late-July plummet in Facebook (FB) after earnings has been the "headliner." I find this fascinating, given that prior to the start of earnings season last month, the fear was that individual company earnings would take a back seat to macro issues -- such as the trade war between the U.S. and China. This directly contrasted to the sentiment expressed prior to the release of earnings in the prior quarter, when the belief was that macro issues would take a backseat to individual company earnings.

The table below sheds light on earnings reactions among SPX component stocks during this reporting season relative to previous quarters. During this earnings season, 55% of companies reacted positively to earnings, which is the highest percentage going back to 2015. Moreover, nearly 16% saw a share price gain of 5% or more -- the second highest percentage going back to 2015.

However, in the prior quarter, only 47% of SPX stocks gained in reaction to earnings, which is the second lowest going back to 2015. And 16% of those companies saw their shares lose 5% or worse, marking the second highest going back to 2015.

Retailers will be a group to watch closely this week, as many are on deck to report earnings.

spx earnings reactions 3Q 2018

"Amid the potential short-term tailwinds from the Fed's hold last week and a sentiment backdrop that could supply buying power, there is resistance immediately overhead on multiple equity benchmarks that could slow or hinder a rally... Resistance on the Invesco QQQ Trust (QQQ - 180.08), the large-cap technology exchange-traded fund (ETF), is at $180, which is 50% above its 2000 peak. The SPX could incur resistance at its January closing high of 2,872... Meanwhile, smaller-cap indexes, such as the Russell 2000 Index (RUT - 1,673.37) and S&P MidCap 400 Index (MID - 2,000.04), continue to struggle with round-number resistance at 1,700 and the 2,000 millennium mark, respectively."
-- Monday Morning Outlook, August 6, 2018

Even though equity benchmarks are higher since the Fed held rates steady on Aug. 1, it is clear that they continue to struggle with taking out the psychologically significant round-number resistance levels that I cautioned you about two weeks ago. The Invesco QQQ Trust (QQQ - 179.86) has had difficulty trying to sustain a move through the $180 area, which is a natural profit-taking zone for those who bought the breakout above the 2000 high.

And the Russell 2000 Index's (RUT - 1,692.95) struggles continue at the round 1,700 level, which hovers just above a profit-taking zone corresponding with the round 10% year-to-date (YTD) return, seen in the first pane on the chart below. Bulls are hoping for a breakout from a symmetrical triangle pattern that has been developing since June.

rut daily - 1700 level

Meanwhile, the SPX is facing resistance from the 2,850 half-century mark in recent weeks, with the January closing high of 2,872 lingering just above.

But perhaps the most intriguing struggle is the S&P MidCap 400 Index (MID - 2,010.19) at the 2,000 millennium level. Note that it was first tested in January, and this first test marked the beginning of a 10% correction. Since June, the MID has been dancing around 2,000 on a regular basis.

The MID's price action here reminds me of 2011, when the index experienced a 27% pullback not long after touching 1,000 for the first time in May of that year. December 2012 marked the first sustained move through 1,000. Bulls hope that this eight-month battle with 2,000 does not turn into a 19-month battle, similar to what happened with the 1,000 level.

mid daily 2000 level

On the heels of a solid earnings season and the Fed holding rates steady earlier this month, I think there is enough buying power to push stocks through resistance before the Fed meets in late September. Per the chart below, short-term traders were as negative as they've been in months ahead of the FOMC meeting and this earnings season. With the 10-day equity-only, buy-to-open put/call volume ratio rolling over from a relatively high level, this could signal that short-term pessimism is unwinding, which is a welcome ingredient to drive equity benchmarks through the resistance levels discussed above.

equity put-call ratio aug 17

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