Risk Edges Out Reward for Post-Fed SPY

Stocks could encounter resistance from their FOMC-day closing levels in the short term

Senior Vice President of Research
Oct 1, 2018 at 8:51 AM
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"The current overbought condition occurs simultaneous with a blackout period for share buybacks and a Federal Open Market Committee (FOMC) meeting scheduled for this week... during the current tightening cycle, one-month SPY returns following a Fed rate hike have significantly trailed one-month returns following a Fed pause."
-- Monday Morning Outlook, September 24, 2018

"Information received since the Federal Open Market Committee met in August indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate... In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 2 to 2-1/4 percent."
-- Federal Reserve Press Release, September 26, 2018

As widely expected last week, the Federal Open Market Committee (FOMC) announced its third rate hike of 2018, and its eighth since the tightening cycle began in December 2015. As noted last week and multiple times during the past several months, equities -- as measured by the SPDR S&P 500 ETF Trust (SPY - 290.72) -- have not performed very well in the month following such rate hikes relative to after a Fed pause. The below table compares SPY returns in the one month following a rate hike versus a pause since December 2015.

spy returns after fed hike vs hold

Amid the current sentiment backdrop and on the heels of last week's monetary policy decision, there would appear to be slightly more risk than reward in the market's short-term status.

For example, the 10-day equity-only, buy-to-open put/call volume ratio gives us a unique glimpse into the real-time sentiment of traders. As you can see on the chart below, when the put/call volume ratio is low in general, the SPY has struggled, even after the Fed paused in late January.

The two times this year that the Fed hiked rates when this ratio was low -- a sign of speculative enthusiasm -- the SPY went sideways at best, and suffered an immediate, albeit modest, decline at worst. In June, for example, the Fed raised rates amid an enthusiastic equity option-buying crowd. The SPY sold off immediately after the hike, and began recovering a few weeks later.

spy daily with bto ratio and fed actions

Last Tuesday, on the eve of the FOMC's announcement, the SPY closed at $290.75, and on the day of the announcement it closed at $289.88. While the SPY is trading around the $289.88-290.75 area, keep in mind that these FOMC-day closing levels have typically marked resistance in the immediate aftermath of a rate hike. Therefore, if the SPY retreats significantly below this area in the weeks ahead, it is probable that future rally attempts could be halted in the $290 area, which coincidentally aligns with the round 2,900 level on the S&P 500 Index (SPX - 2,913.98).

Immediately above the SPY's FOMC-day closing levels is $293.54, which represents a round 10% year-to-date gain and marked the September high. In other words, from a technical perspective, there seem to be speed bump in the immediate vicinity of the market or just overhead that add to our concern about the increased probability of limited upside in the weeks ahead.

As I mentioned last week, other major equity benchmarks are battling psychological round-number areas, too, which raises the odds of lethargic market action in the weeks ahead. In fact, the Russell 2000 Index (RUT - 1,696.57) was pushed back below the round 1,700 area last week, after consecutive closes above this level from Aug. 21 through Sept. 25. RUT has been doing battle with 1,700 since June, unable to distance itself significantly above this century mark.

Additionally, the S&P MidCap 400 Index (MID - 2,019.55) pulled back to the 2,000-millennium mark last week, after re-testing its late-August highs the week prior. The 2,000 level was first touched in January 2018 -- and nine months later, the index is still trying to put this level behind it for good. The action around the MID 2,000 level is reminiscent of April 2011 through January 2013. There was a corrective move from both the 1,000 and 2,000 levels, followed by several touches of these millennium levels months later. If past is present, the MID may only be halfway through trying to distance itself for good from 2,000.

mid daily 2011-2013

mid daily 2018

While resistance levels are in place overhead, the good news for bulls is that significant levels have not been broken to the downside, and the SPY made a new all-time high as recently as seven trading days ago.

A support level if the SPY retreats is the January high in the $286 area, and further support from a channel line connecting higher lows since March is at $284. In other words, there is major support from $284 to $286 going into this week's trading. This area is equivalent to 2,840 and 2,860 on the SPX, or around the 2,850 half-century mark. If this area breaks in the weeks ahead, we could see a surge in volatility, as the "wrong-way" Commitments of Traders (CoT) large speculators are still net short Cboe Volatility Index (VIX) futures.

A sector to avoid is financials, which had a disappointing September, even as financial-related exchange-traded funds (ETFs) saw major inflows during the month.

spx daily uptrend channel

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