“The rally pushed the SPX back above its 80-month moving average, and a close above this trendline today would certainly be a positive for bulls.., last week’s advance does not suggest upping your allocation to levels seen before the pullback, as the SPX remains below its 36-month moving average…Friday’s decline from its 1,000-day moving average is something to note too, a trendline that was supportive at the December 2018 low”
- Monday Morning Outlook, March 30, 2020
In last week’s commentary, I observed that the S&P 500 Index (SPX - 2,488.65) was about to experience a monthly close above its 80-month moving average, a trendline that has acted as support on major pullbacks in the past, keeping the bulls’ hopes for a highly debated market bottom to be in place.
However, monthly closes below this off-the-radar moving average have preceded continued weakness for months, suggesting further lightening up on equities if such a technical event occurs. While the SPX rallied strongly from an intra-month move below this trendline, its March close was below two other historically important longer-term moving averages that we track, suggesting the bulls aren't out of the woods yet.
Specifically, the SPX remained below its 1,000-day moving average, which was the site of the December 2018 trough, and its 36-month moving average, which is the site of multiple historical lows. When the SPX has broken down past these two trendlines, however, it has led to a further decline to at least its 80-month moving average, which happened quickly last month. If you want to review the historical significance of the SPX’s 36-month and 80-month moving averages since 1959, please see my March 16 commentary.
This “encouraging, but not that encouraging” technical backdrop for bulls is standing against an unceasingly uncertain environment in which there's no telling how long Americans and the rest of the world will take actions that and undermine the economy in order to manage the COVID-19 pandemic.
I have seen gross domestic product (GDP) estimates for the second quarter range from a 25% to 30% decline. This seems like an easy number to beat, but then again employment numbers came in much worse than expected last week, even with economist forecasting coronavirus-related job losses. With consumers driving the economy, market participants late last week were likely implying that GDP and earnings estimates may have room to move lower.
There is also the question of how long the virus will be around, and how long government-mandated safety measures will remain in place to contain its spread. The situation is fluid, and the uncertainty is weighing on the market, as many questions remain left unanswered by the health experts.
For example, as I watched Ohio Governor Mike DeWine and Ohio Health Director Dr. Amy Acton deliver their daily press conference on Friday, with Ohio being a state that has been on the forefront of mitigation efforts to stem the spread of the virus, Acton reiterated that the longer we flatten the curve, the better, as this buys more time to increase hospital space, and acquire the necessary equipment and supplies to help patients battle the symptoms of the disease.
Buying more time is viewed as a necessity to saving lives, which is where the priorities are, at least with most states. At the same time, the economy suffers the longer that we accomplish the goal of “flattening the curve” -- a curve that I am sure that you are familiar with by now.
As such, what we thought may have been mitigation policies that last about two weeks is now six weeks. And, from what I gathered from the Ohio press conferences on Thursday and Friday, mitigation efforts to flatten the curve could very well last into early summer, although this is not yet official. Meanwhile, there are other unknowns to ponder -- will there be a second wave later in the fall? When will a vaccine or treatment be available? The longer these questions go unanswered, the longer that volatility will stay around.
“… So how can you remain not just unemotional, but rational, especially with the next monthly close data point weeks away? One potential action after this rally is to lock in your risk, using the SPX’s 80-month moving average as your guide to defining said risk during the next few weeks. For example, buy weekly 5/1 SPDR S&P 500 ETF Trust (SPY – 253.42) puts, or a put debit spread to hedge a month-end close below the SPY’s 80-month moving average (which is currently at 235). The SPY 235 level corresponds to roughly SPX 2,350.”
- Monday Morning Outlook, March 30, 2020
But just as health experts are operating in a volatile environment filled with unknowns, they have a road map to follow to manage those unknowns and mitigate the associated risks. As an investor, you should have a road map too, with a risk mitigation plan to fall back on during these times. As such, I am reiterating what I said last week, in terms of a hedging strategy to implement for long positions in your portfolio.
Sentiment indicators suggest that a huge rally could come if there are any positive surprises related to the coronavirus. I touched on some of these sentiment indicators last week, including the multi-year high in pessimism among option speculators and the enormous short covering among large speculators on CBOE Market Volatility Index (VIX -- 46.80) futures.
Another sentiment indicator that we monitor is the weekly National Association of Active Investment Managers (NAAIM), which is suggesting an extreme low in this group’s current equity market allocation. However, the 10-week moving average of this allocation is still not at an extreme low, suggesting it could be weeks, if not months, before this group of participants lends support to the market, after what appears to be indiscriminate selling last month.
The implication is that while this group is not likely to be a source of huge selling power in the weeks ahead -- arguing for less equity downside risk -- it may not be a source of buying power either if the shorts continue to build positions like they did in the first half of March, as illustrated in the second graph below. If the shorts continue to exert influence, bounces like we saw in late March will be brief, which argues for having a hedge in place with the SPX above its 80-month moving average, but still below other long-term moving averages as well as the trendline connecting higher lows since 2009 -- as displayed in the graph above.
The following graph shows that shorts are emboldened, but overall level of short interest is still far from its 2016 peak.
Todd Salamone is Schaeffer's Senior V.P. of Research
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