Potential Buying Opportunity as Deep Pockets Return to Stocks

The SPX 2,640 area should be of particular interest to stock traders

by Matthew Timpane

Published on Feb 11, 2019 at 8:29 AM
Updated on Feb 12, 2019 at 4:08 PM

Bears jumped on last Thursday's news that a trade deal with China was doubtful before the March 1 deadline -- with the White House later confirming that it would be highly unlikely that President Donald Trump and President Xi Jinping could meet to hammer out the final details before the deadline. The news happened to coincide with the S&P 500 Index (SPX - 2,707.88) being within striking distance of its 200-day moving average just a day earlier and, ironically, the May 2018 highs after its breakout earlier that month. I suspect these technical levels only added to the selling pressure, as many technicians were likely already shorting against this resistance.

SPX daily MMO 1

Therefore, while traders had been riding the tailwinds from the 2019 Fed decision to be patient with rate hikes, the other tailwind of a potential China trade deal has now become a temporary headwind as negotiations appear to still have a "sizeable distance" to go, according to National Economic Council Director Larry Kudlow. Furthermore, another government shutdown is looming on Friday, Feb. 15, which already had many market participants on edge, as there seems to be little bipartisan compromise on President Trump's demands to include funding for the southern border wall. 

However, on Friday, just minutes away from the first negative weekly close of the year in the S&P 500, the bulls pulled off a last-minute rally to push the index fractionally higher. Not surprisingly, the 270-strike put on the SPDR S&P 500 ETF Trust (SPY - 270.47) weekly 2/8 contracts happened to be the largest area of open interest, and subsequently, more than 40,000 contracts ended up expiring worthless due to the last-hour rally.

SPY weekly OI MMO2

In addition to the SPX running into overhead resistance near the 200-day moving average, the Nasdaq Composite (IXIC - 7,298.20) also neared resistance at its 200-day moving average. Consequently, market participants shouldn't have been surprised by last week's price action, with multiple market indices due for a pullback and the Relative Strength Index (RSI) on the SPX and IXIC daily charts approaching overbought levels.

Meanwhile, market breadth also found an area of resistance that is typical of markets rebounding from correction territory. Last Wednesday, around 50% of the S&P 500 stocks had crossed above their respective 200-day moving averages, which is an area where various rallies from correction territories have historically stalled, as we can see referenced in the chart below.  While this indicator doesn't tell us if we are only pausing before a further advance, if we're going to retest lows -- or see new lows -- it will give market participants a reason to remain hesitant until we see directional confirmation.  

SPX stocks above 200day MMO3
Chart courtesy of Stockcharts.com

"Finally, the SPX closed above potential trendline resistance connecting the early October high to the early December high on Wednesday, the day the FOMC kept rates steady and Chairman Powell held a dovish press conference. That said, follow-through buying pushed the SPX slightly through the 2,700 century mark, but there seemed to be a 'stall' in the 2,705 zone -- which ironically, was the site of the May 2018 breakout area of a potential trendline connecting the January and March 2018 highs. This level acted as support in late June 2018, too."

-- Monday Morning Outlook, February 4, 2019

As previously mentioned, the SPX closed fractionally positive for the week, which gave us a doji candlestick on the weekly chart, after trading down and bouncing off its 80-week moving average at 2,684.21. Subsequently, the last-minute rally also mentioned earlier managed to regain the May 2018 breakout area that connected the January and March 2018 highs discussed last week. This market action only further confirms that traders are in an area of indecisiveness.

SPX weekly chart MMO5

Other sentiment indicators continue to corroborate last week's behavior, as the American Association of Individual Investors (AAII) survey data shows that many participants remain apprehensive, with an elevated neutral sentiment reading at 37.3%, which is above its historical average of 31.4%. Meanwhile, the 10-day equity-only, buy-to-open put/call volume ratio is still rolling over from highs, evidence that pessimism continues to unwind, but far from levels that indicate full-fledged optimism. 

put call ratio MMO4

Additionally, the SPY, Invesco QQQ Trust (QQQ), and iShares Russell 2000 ETF (IWM) put/call volume ratio is still tracking upward, which indicates that deep-pocketed hedge-fund money continues to make its way back into stocks and is coincidentally supportive when these participants are in the accumulation phase. To support this, the first week of February (as of 2/6/2019) turned around negative fund flows, with a bit of rebalancing in which we saw -- for the first time in 2019 -- positive North American money inflows into equities by the tune of $3.09 billion. While this is not an extraordinary amount of inflows by any measure, it's still a step in the right direction for those that are betting on a continued rebound, and a welcomed change from the mass exodus of capital that fled equities into money market funds in December and January.

"If you are a short-term trader, and a pullback occurs, the SPX 2,630-2,640 area is a potential line of defense, as this area marks the closing lows in October and November 2018, in addition to Tuesday's close ahead of the outcome of last week's FOMC meeting. As we look ahead to mid-February, the declining trendline that connects the October and December peaks would be at 2,640. Note that a re-test of the line connecting the January and March 2018 highs occurred in late-May 2018.

A second line of defense occurs in the 2,580 zone, or the February and March 2018 lows. If Friday marks a high of some kind, a 61.8% retracement of the December low and Friday high is situated at 2,580."

-- Monday Morning Outlook, February 4, 2019

Thus, while we may continue to see a short-term pullback after the 200-day failure, we should look at potential support areas of 2,640 and 2,580 as potential buying opportunities. The 2,640 area should be of particular interest amongst traders, as we previously mentioned last week that it marks the October and November 2018 lows, and the breakout of the declining trendline connecting the October and December peaks. Moreover, the 50-day moving average will likely have risen to this critical level, and technical indicators will have wound down from their overbought levels giving bulls a chance at a good risk/reward setup.

  

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