Risks Remain, But Bullish SPY Chart Pattern Still in Play

Sector rotation is creating opportunities to profit on both the bullish and bearish sides of the market

Senior Vice President of Research
Nov 19, 2018 at 8:24 AM
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"...the equity-only, buy-to-open put/call volume ratio rolled over from a relatively high level. The roll-over in this ratio implies that the pessimism that was building in October and pressuring stocks lower climaxed, an important ingredient for carving out a bottom after a sharp decline... The SPY high last week was at its declining 40-day moving average, but the 200-day moving average, which caught much attention on the break below, held as support. After Friday's move back below $280, bulls should seek a move back above this round number and the FOMC decision-day close of $280.50, before getting aggressive to play a bullish FOMC move and sentiment unwind."
-- Monday Morning Outlook, November 12, 2018

After a Monday sell-off and continued weakness as November options expiration week progressed, the SPDR S&P 500 ETF Trust (SPY - 273.73) battled back by week's end to settle above Monday's close. Despite last week's decline, the SPY did manage to hold above key levels.

For example, per the daily chart below, the SPY found support in the $270 area on a daily closing basis. This level, which corresponds with the S&P 500 Index's (SPX - 2,736.27) round 2,700 century mark, has been supportive on pullbacks going back to May. Round levels have been significant short-term pivot areas during this pullback, with 2,800 acting as resistance recently following a rally from the late-October low in the 2,600 area.

Moreover, the SPY 270 strike was the site of heavy put open interest that expired on Friday. With a majority of this open interest generated by option buyers, the hold above here was important, as short-covering related to the expiring puts likely had a hand in the Friday rally -- effectively keeping alive the potential for a bullish inverse "head and shoulders" pattern to play out if resistance at the Oct. 17 and Nov. 7 closing highs just above $280 is taken out within the next few weeks.

spy inverse head and shoulders

"...during the past several years, breaches of the 200-day moving average have marked lows or near lows more so than being predictive of bear market action... That said, there is often a volatile, choppy phase that equity markets endure in the following weeks and months after a break of this trendline. Whether the current breach signals a bear-market phase remains to be seen. My message is to be careful about the longer-term implications of the 200-day moving average breakdown..."
-- Monday Morning Outlook, October 29, 2018

The SPY remains below the key $280 area, and the CBOE Volatility Index (VIX) is above half its 2018 closing high at 18.66, indicating that there is still enough risk for bulls to hedge long equity exposure. But last week's intraday low in the $268 area occurred at levels that I observed on Twitter and in a commentary late last month as potentially important on pullbacks, which would imply that bears should not be overly excited at this point.

Specifically, the lows last week were concurrent with the 320-day moving average just below $270, which is also four times the 2009 low. Therefore, the SPY is firmly entrenched between key support and resistance levels, which may explain the volatile, choppy action that we have seen the past few weeks. And don't forget that we place much emphasis on the 80-week moving average, currently situated at $264, as a demarcation point between bull and bear markets. A weekly close below this trendline would suggest heightened risk of bearish action over the intermediate to long term.

The jury is still out as to whether the current action precedes another serious leg down or a continuation of the longer-term uptrend. But it does follow the script that I described late last month when pointing out that past breaks below the 200-day moving average do not have a good track record of foreshadowing long-term bearish price action. However, short-term volatile, choppy action like we are seeing now tends to be an immediate byproduct of such breakdowns.

I think the fact that the VIX has not taken out its highs from last month is reflective of the fact that there are pockets of strength, despite the focus on technology names -- particularly FAANG -- taking a beating since the start of the fourth quarter. The rotation out of technology has been met with strength in other groups, such as drugmakers, airlines, and restaurant and apparel stocks. This sector rotation is giving market participants opportunities to profit from both sides of the market. So the risk at this juncture is locking yourself into a strong bullish or bearish broad-market view, as you may miss opportunities that present themselves from the opposing perspective.

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