3 Sectors That Throw Doubt on the Breakout

The SPX barely edged above 2,820 last week, leaving stocks on tenterhooks ahead of the Fed

CMT, Senior Market Strategist
Mar 18, 2019 at 8:28 AM
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Last week’s bullish price action during March options expiration week appears to have taken out technical resistance at the S&P 500 Index (SPX - 2,822.48) 2,820 level by a sliver, which happens to be 20% off the December 2018 lows. While last week’s rally was propelled by a few factors, the dollar’s failure to break out, combined with the SPX resting on minor support at 2,730, along with a few buy signals in short-term indicators, was enough to perpetuate a bounce. Although the dip in the first week of March proved to be more than enough of an unwind for overbought short-term indicators, which allowed the market to make another run at that SPX 2,820 resistance level, it’s certainly at risk for a possible failure, since last week's wasn’t a decisive breakout.

dxy daily chart since may 2017

"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."
-- Monday Morning Outlook, February 25, 2019

My bet is traders will continue to be focused on the SPX 2,800-2,820 area this week, watching for a pullback or a decisive breakout, since it was the October rebound level and November highs that proved to be a formidable pivot point in last year's fourth-quarter sell-off. Also, I expect we won’t see a resolution of this indecision until after the Fed meeting on Wednesday, where it is largely expected that the Federal Open Market Committee (FOMC) will leave rates unchanged, and market participants will be more concerned with the language used in the Fed's economic outlook.

spx daily chart 0317

As we know, this historic rebound off the Dec. 24 low has largely been led by technology. However, last week, we saw defensive sectors such as healthcare, utilities, and consumer staples perk up on the rally, making me a bit more hesitant that this slight breakout will hold. While a case can be made for a utilities rally based on the Fed's new approach of “pause” and "patience” causing yield-seeking investors to rotate away from bonds as Treasury yields continue to fall, just as a case can be made for the healthcare sector being oversold on the “Medicare for all” rhetoric coming out of Washington, D.C. -- it's consumer staples that concerns me.

All three sectors have been lagging the market year-to-date, and if you couple last week’s rally with the weakness in the industrial sector as a whole, you can see why caution is now warranted, at least for the near term. Most will attribute the weakness in the industrial sector to the recent news regarding Boeing (BA), but we’re also seeing weakness in trucking and other industrial names. While these factors certainly warrant skepticism, it’s not enough to say the rally has ended.

Last week’s headlines were full of bulls and bears making their cases for which way they feel the market will go next as we struggle to find direction in the face of the aforementioned resistance area, but what caught my attention was that I started to see seasonality pop up regarding March and April. Spring indeed is a seasonally strong period, with March and April being largely positive over the last 20 years -- the SPX finishes March higher 70% of the time, and April 74% of the time -- but I wanted to know what we can expect going forward.

To begin with, since 1928 we find that the market on average does rally from the beginning of March through the end of April, finishing positively +1.44%. Typically, March starts out flattish and slightly skewed positive. Historically, the market rallies mid-month before pulling back in the final week and finishing somewhat positive, around +0.55%. While we sold off by -2.16% to begin March, we have since reverted to the mean and are slightly positive, with a return of +0.67% on the SPX since the March 1 close.

In order to concentrate on our current time period, I took the last 10 years’ worth of SPX returns following March options expiration (OPEX) week and extrapolated it six weeks forward to get a better idea of where we are now. What we find the following week after OPEX is typically a relatively flat-to-negative market with an average return of -0.30% and a median return of -0.49%. As we work our way through March and April, the data becomes more positive -- but in conjunction with the data that goes back to 1928, we seem to rally more towards the end of April than in any other period. One reason for this could be April OPEX, and there is a possibility this could happen again with the growing open interest in SPDR S&P 500 ETF Trust (SPY - 281.31) calls at the 285 strike, which could cap the gains until expiration.

It also can be argued that 2009 does skew the data in a positive direction as we rallied out of the Great Financial Crisis, but when removing that year, we find it mostly affects the average percentage of positive returns, and drops those returns to roughly +1.50%. So, if past is prologue, we can expect a relative move of +/-1.50% through the end of April.

spx returns after march options expiration

spy april 2019 open interest by strike

Regarding sentiment data, the 10-day equity-only buy-to-open put/call volume ratio rose substantially last week amid multi-month highs in the SPX -- evidence that near-term optimism is waning. As market participants continue to show a penchant for purchasing puts over calls, this could be setting us up for a further rally after a possible price consolidation through time or price in the coming weeks.

equity put-call ratio 0317

Finally, the American Association of Individual Investors (AAII) survey data last week delivered the largest two-week increase in bearish sentiment since mid-December on a point basis. So, while the 10-week bearish sentiment average is currently at 28.1% -- the lowest since July 2018 -- we are seeing bearish sentiment increase rather quickly as we fight with technical resistance at SPX 2,820.

The market very well may see a pullback in the next few weeks as short-term indicators remain overbought, but we have solid support around the SPX 2,700 level, as we’ve previously mentioned. And with sentiment and seasonality factors becoming favorable in the coming weeks, we should look at any potential pullbacks as possible buying opportunities until the data changes.

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