Bullish Technicians Might Be the Minority

All eyes are on S&P 2,800, but don't miss the significance of 2,820

Senior Vice President of Research
Feb 25, 2019 at 8:36 AM
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"...after an initial hesitation, the SPX pushed through the 2,758 level, which is 10% above its 2018 close... one should not be surprised to see a retreat below 2,758 in the absence of positive headlines this week ...The next obvious hurdle for the SPX is the round 2,800 area, which the index surrendered to briefly in March, June, October, and November 2018. For what it is worth, 2,820 is 20% above the December 2018 closing low and might be worth watching if the SPX manages to push above 2,800 in the weeks ahead."
-- Monday Morning Outlook, February 19, 2019

A positive 1-2 punch on U.S.-China trade and the Fed's intentions on monetary policy helped propel the broad market higher last week. Market participants were buyers as President Trump's meeting with China's top negotiator was viewed as progress. Moreover, the Federal Reserve was a positive driver of market action on Friday, after its semi-annual report contrasted sharply with that of July 2018. The report on Friday indicated that the Fed intends to remain "patient" in making changes in interest rates due to a slowing global economy -- whereas in July 2018, the Fed signaled its intent to keep raising rates at a gradual pace.

With that said, market participants put profit-taking on the backburner, an action that I suggested last week was a possibility after the S&P 500 Index (SPX - 2,792.67) gained more than 10% from its 2018 close.

Anecdotally, there is a mix of optimism and caution on the technical front. On one hand, whether you're following financial television, social media, or other publications, the SPX's 2,800 level is on the radar of many chartists as a potential resistance area -- a level that is now very much in view. This is an important level, as it is a round number and the site of the past highs as I mentioned last week. But if indeed a short-term top or a hesitation in the upside momentum occurs, I would find it interesting if it occurred at 2,820 -- a level that is a round 20% above the December closing low, and not on the radar of many as a potential hesitation point.

spx daily chart 0224

"Some investors point to signs of breadth in the recent rally as an encouraging sign... Another bullish sign for stocks: the NYSE advance-decline line, a popular indicator of market breadth that tracks the number of stocks rising minus the number falling each day, has hit new highs. Meanwhile, 91% of S&P 500 stocks on Thursday were trading above their 50-day moving average."
-- The Wall Street Journal, February 22, 2019

On the other hand, as more and more stocks participate in the rally, more optimism creeps into the market, which can eventually leave it vulnerable. The excerpt above appeared in an article in The Wall Street Journal on Friday, which listed multiple bullish technical factors for the market. This caught my attention from the perspective that when there are multiple technical signals pointing in one direction -- in this case, higher -- it might pay to be on guard for a deterioration in the technical backdrop.

But being "on guard" does not mean rushing out and selling everything, as momentum like we are seeing now has a way of staying around longer than anticipated. As long-time readers know, I am a strong advocate of using option-buying strategies to leverage upside and simultaneously manage risk.

And as I said a couple of weeks ago, with earnings season winding down, equity options are cheap as earnings volatility is no longer embedded in the premium. This means you can achieve tremendous leverage on call options to play anticipated upside in stocks that you like. It also means that hedging costs are lower if you own stock and want to use puts as a hedge, if you think SPX 2,800 becomes an endpoint to the rally.

When assessing the overall sentiment backdrop, technicians may represent a minority that believes in the rally, which is a good thing for bulls. It suggests sideline money from those fearing an "earnings recession" or a resolution to the U.S.-China trade standoff could become available to further drive stocks.

For example, in early February, Goldman Sachs stated investors are "out of luck" if they missed the January rally. And Morgan Stanley Wealth Management warned last week that investors are too optimistic about a resolution to the China trade dispute.

Moreover, Friday's Commitment of Traders (CoT) report revealed that SPX e-mini futures contract traders were net short as of the first week of February. And finally, equity-only option buyers, per the chart immediately below, are still in "unwind mode" after hitting a pessimistic extreme in December, but the increased optimism is still not at levels that have marked short-term tops.

equity option buying activity 0224

With a dovish Fed, a growing bullish technical crowd may be proven correct in the days ahead.

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