Is The S&P 500's Rally Officially Over?

Total short interest levels on SPX component stocks is at a level that, in most instances, define a low point

Senior Vice President of Research
Aug 17, 2020 at 8:35 AM
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"…as you have heard many times before during the past few months, it seems that each time the SPX takes out a resistance level, no matter how long it took to do so, there is a level (or levels) lurking just overhead that could present the next hesitation or pivot area, as market participants reassess market exposure…. with the SPX already through the round 3,300 level, the two levels overhead that I am focusing on now are 3,356 and 3,386. The former is 50% above the March 23 year-to-date closing low … Meanwhile, 3,386.15 represents the SPX's closing high six months ago, on February 19."

            -Monday Morning Outlook, August 10, 2020

Equity option buyers, active investment managers and active traders continue to show significant amounts of enthusiasm toward equities. But that sentiment continues to be aligned with price action, as the S&P 500 Index (SPX) touched its February closing high of 3,386.32 in the middle of last week.

While the SPX was unable to take out the February closing high mark, it was clearly noticeable that resistance came into play. However, those looking to lighten positions at a peak that happened six months ago did not overwhelm buyers, as the SPX remains well above its 30 and 40-day moving averages -- both of which have supported relatively shallow pullbacks since the SPX climbed above these trendlines in early and mid-April. 

8-14chart 1

Based on Friday's close, it would likely take a pullback of about 4-5% to push the SPX below these moving averages, or below former resistance at 3,230 -- the site of its 2019 close -- in order to dull the enthusiasm among these groups of traders that have helped push stocks higher.  

In other words, the market remains vulnerable to equity option buyers slowing the relentless pace in which they are buying equity calls (an upside bet on a stock) relative to puts (a downside bet on a stock). Moreover, the National Association of Active Investment Managers (NAAIM) reported the highest equity exposure among this group of participants since mid-June 2018. For what it is worth, the SPX retreated 3.1% in the second half of June 2018.

8-14chart 2

But for now, price action trumps the sentiment backdrop, even as the SPX battles its February high, while other major benchmarks battle other types of chart resistance. For example, the Nasdaq Composite (IXIC) first touched the round 11,000-millennium level on August 5, and has gone sideways since. 

Continuing with the round-number theme, the Russell 2000 Index (RUT) has shown outperformance for a couple of weeks, but paused at the round 1,600-century mark last week -- a level that has initiated multiple battles over the past couple of years, some of which have been won, many of which have been lost. While the RUT has paused at 1,600, it would likely take a move below 1,550 by week's end to unnerve small-cap bulls, as this is the site of a trendline connecting higher lows since March.

8-14chart 3

Finally, the headline Dow Jones Industrial Average (DJI) paused just below its round 28,000 millennium level, after last trading above this level in February. It's worth noting that just 500+ points north of here, at 28,538, is its 2019 close. 

One chart that caught my eye last week was total short interest on SPX component stocks. On one hand, the covering activity taking place during the past several weeks is supportive of the market -- and bulls would like to see such activity continue. But also obvious on this chart is that total short interest on these components of the index is at a level that, in most instances, defines the low point. If past is prologue, equities might incur a headwind, should we see short interest bottom out again. 

SPX short interest overlay

With some sentiment indicators flashing caution, such levels mentioned above represent potential areas from which the equity benchmarks I discussed could reverse the course that has been set since the March lows. But so far, such levels of potential resistance have generated only pauses in a rather impressive uptrend. Therefore, do not fight the uptrend until something changes with respect to the trend that has been in place for the past five months, such as a trendline or moving average that has tended to act as support no longer doing so if sellers emerge.

The one group that continues to be unconvinced is traditional domestic mutual fund participants, who might be glued to gloomy headlines and detached from price action.  Investment Company Institute (ICI) is estimating that July outflows were the highest since December 2019. On one hand, this represents sideline money that could support the market on a pullback. On the other hand, give this group credit, as big outflows in December and January preceded a historical selloff in equities in February. But these same investors have missed the ensuing rally, hammering home the idea that they have cash to deploy into the stock market at some point in the future.

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

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