Potential S&P Resistance Just Came Into Play

A volatility pop remains a risk as VIX moves off its year-to-date floor near 12

Senior Vice President of Research
Nov 25, 2019 at 8:07 AM
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After six consecutive weeks of gains in which the S&P 500 Index (SPX - 3,110.29) advanced 5.7% to a record high, the index finally gave up ground last week. But the 10-point pullback is hardly noticeable, as the SPX closed the week above both the round 3,100 century mark and its 10-day moving average.

One thing that stands out about last week is the SPX's weekly high, which occurred around 3,128. Per an observation I made on Twitter last Tuesday, this high was two points shy of the 3,130 level, which is roughly double the peaks that preceded two memorable bear markets, beginning in 2000 and 2007. For those who bought the breakout above these levels in April 2013, it would not be surprising to see some profit-taking emerge at double the breakout level. Therefore, the 3,130 area is one to keep an eye on in the days and weeks ahead as a potential resistance zone.

Noteworthy, too, was the inability of the S&P MidCap 400 Index (MID - 1,985.87) and Russell 2000 Index (RUT - 1,588.94) to take out the 2,000 and 1,600 levels, respectively. I've discussed the MID 2,000 and RUT 1,600 levels in detail, and even though they acted as resistance again last week, patterns are evident on both indexes that are bullish in the intermediate term.

With the SPX retreating mildly from a resistance zone last week, also of note is how the index is moving out of an overbought condition that it entered earlier this month, according to its 14-day Relative Strength Index (RSI). As you can see on the chart below, previous overbought conditions in 2019 haven't timed pullbacks as perfectly as oversold conditions have timed bounces due to the uptrending nature of the market, but the SPX has been most vulnerable to a pullback after spending a few weeks in or near overbought mode.

If a pullback does emerge, an area of potential support is at the highs in July and September that mark the top of the bullish ascending pattern I have discussed in prior weeks. This area is just above the 3,000 millennium mark, in addition to the general area in which the SPX was trading prior to the three rate cuts that occurred since late July, marked by the down arrows in the chart below.

spx daily 2019 with fed rate cuts

"... the breakout from the ascending triangle targets a move to the 3,200-3,225 area sometime in the first quarter. For bulls, the breakout is a positive development, as the sentiment backdrop is supportive of the anticipated rally, whether it is short-covering potential, asset allocation moves from bonds to stocks among investors in exchange-traded funds (ETFs), or fund managers moving back into equities after raising cash prior to the breakout."
-- Monday Morning Outlook, November 4, 2019

While the short-term outlook poses some risk, the SPX appears on target to eventually reach the 3,200-3,225 area sometime in the first quarter of 2020, implying patience will likely be rewarded.

From a sentiment perspective, an encouraging sign for bulls is that while the 10-day, equity-only, buy-to-open put/call volume ratio has sharply declined from its peak, it is still not at an extreme low that has historically marked vulnerability to a notable pullback in the market. This might imply that the SPX support zone I described above does not get tested, even if the market doesn't make considerable headway in the near term.

equity buy to open ratio 1124

"... nothing is certain -- so buying VIX calls in anticipation of large speculators eventually being on the wrong side of the next major volatility move, or call options on the iShares 20+ Year Treasury Bond ETF (TLT - 137.76) after it recently bottomed at its 160-day moving average and round 10% YTD level, could be worthwhile hedges to a long equity portfolio."
-- Monday Morning Outlook, November 18, 2019

Last week I highlighted the risk of a volatility pop due to several factors -- including the huge net short position on Cboe Volatility Index (VIX - 12.34) futures by large speculators in the Commitments of Traders (CoT) report, a group that has been wrong-footed at every every major volatility turn.

It is also worth mentioning that the VIX has been lingering in an area that has marked bottoms in 2019, which is around half its 2018 close in the 12 area. At present, the VIX is advancing from the 12 handle again; but fortunately for bulls, it has not been a spike like we saw in April and July.

vix daily chart with 2019 floor

That said, this VIX floor in the 12 region poses upside volatility risk, which equity market bulls should continue to take into account. A potential bullish scenario is the VIX continuing to work higher amid little to no damage in the equity market, giving it room to work its way lower back to 12 amid a breakout from a range.

Todd Salamone is Schaeffer's Senior V.P. of Research.

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