The "fear index" closed last week below two recently supportive trendlines
"... [T]here has not been a steady stream of call buying relative to put buying on VIX futures like we saw ahead of the late-July/early August volatility surge that occurred when President Trump announced the U.S. would impose 10% tariffs on an additional $300 billion in Chinese goods...
"One risk that I see is that volatility could still be trending higher, as the VIX remains above its 80-day moving average at 16.23, with its Friday morning low at 17.09 occurring just above its 200-day moving average. Both trendlines have marked support on "volatility pullbacks" recently...
"But betting on the VIX breaking below these trendlines is not a bad bet to make... And the VIX is showing a pattern reminiscent of prior peaks, with 'aftershock' advances that make a lower high following the first peak."
-- Monday Morning Outlook, September 3, 2019
Per last week's discussion, a bet on declining volatility was indeed a good one to make, as the Cboe Volatility Index (VIX - 15.00) plummeted last week, and closed below the 18 level on Friday -- half the 2019 peak. Driving stock prices higher and volatility expectations lower were easing tensions in Hong Kong over the China extradition bill, and word that the U.S. and China have scheduled trade talks in October.
The VIX closed below its 80-day and 200-day moving averages, trendlines that supported "volatility pullbacks" before two minor "aftershock" advances last month that did not take out the early August peak. Dare I say it, but ahead of a Federal Open Market Committee (FOMC) meeting in the middle of next week and preliminary trade talks in advance of higher-level meetings in early October, indications are that the VIX could be headed back to the 12 area that has proven to be a floor this year.
"... [I]f 2019 continues to 'rhyme' with 2014, you can make a sentiment case for at least a retest, and quite possibly a breakout above 3,000, if bearish sentiment unwinds."
-- Monday Morning Outlook, September 3, 2019
Last week, I compared today's environment to that of 2014, including rejections at S&P millennium levels that led to single-digit percentage corrections, and the drivers being somewhat alike -- including a strong dollar sparking concerns about U.S. competitiveness and dampening U.S. inflation and growth (a concern prevalent again today).
The price action in the first week of this month sets up a retest of 3,000 after the S&P 500 Index (SPX - 2,978.71) rallied sharply, breaking out above the 2,945-2,950 area, which not only marked short-term peaks around Fed meetings in May and June, but also multiple highs last month. The 2,950 level also marked a high in September 2018 when the Fed raised the fed funds rate.
If equities pull back, the area between 2,945 and 2,950 would be the first line of potential support. A second line of defense would be the round 2,900 area, which -- through the end of this week -- marks the SPX's rolling year-over-year (YoY) breakeven level. As mentioned in prior commentaries, this area has been supportive on multiple occasions since late February.
Resistance is close overhead, with the psychologically important 3,000 millennium area in the vicinity of the round 20% SPX year-to-date gain (3,008), as well as the 3,013 close the day prior to the Fed cutting rates on July 31.
Since the SPX found support on multiple occasions at its "off-the-radar," but important, 160-day moving average last month, negative sentiment has continued to unwind, which is supportive in the near term. And bulls should note that short-term optimism, as measured by equity option buyers (second chart below), has not yet reached levels that suggest the current rally is in real danger of ending.
Above said, with an upcoming Fed meeting just eight trading days away and U.S.-China trade talks around the corner, it is an environment that traders have to carefully navigate. To the degree Mr. Trump views this rally as another opportune time to tweet something negative about the Fed or trade talks with China, traders must take precautions.
Therefore, I continue to advise using options as a risk-management tool -- especially with volatilities falling recently, making options cheaper for premium buyers.
Todd Salamone is Schaeffer's Senior V.P. of Research.
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