The Next Big Hurdle for the S&P 500

Are we on the verge of a correction like that of September, or another consolidation like we saw to end 2020?

Senior Vice President of Research
Jan 25, 2021 at 8:36 AM
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“…despite the headlines, some of which could have given the bulls pause, the SPX never breached the rising 20-day moving average, which sits below the first level of potential support on a pullback, which is the 2020 close of 3,756.07.”

          -Monday Morning Outlook, January 11, 2021

There remains little reason to disturb long positions, as the equity markets continue to trend higher.  In fact, the Nasdaq Composite (IXIC—13,543.06), Russell 2000 Index (RUT—2,168.76) and S&P 500 (SPX—3,841.47) carved out new all-time highs last week and are trading well above their respective short-term support levels. This is important, as the price action has given little reason for the growing number of optimists to unwind positions that are moving in their favor.

For example, in the SPX chart immediately below, a first level of potential support remains in the 3,745-3,756 area, which is the site of last year’s close. The rising 30-day moving average, which is currently sitting at 3,744, resides just below this level and has acted as intraday support twice this month (on a closing basis, the more popular 20-day moving average has held pullbacks).  

From this vantage point, it might take a move into the red, relative to last year’s close, or a sign that momentum could finally be swinging the other way -- using the 30-day moving average as a guidepost -- for the growing bullish crowd to hit the brakes.    

January 24 MMO Chart 1

While the RUT made an all-time high last week, the intraday high at 2,173 was intriguing, as this is a round 10% above its 2020 close. Long-time readers of this commentary are aware of the importance that I assign to levels that correspond to round year-to-date percentage gains or losses, as they are often hesitation or pivot points.

The first level of RUT support is at 2,065, the site of its rising 20-day moving average that marked the early January low. The 1,975-2,000 area marks another potential support level, but there is admittedly a lot of ground level to cover before this area is within view. The 1,975 level is the site of the RUT’s year-end 2020 close and roughly double the March 2020 closing low. Meanwhile, the round 2,000 millennium mark was the site of the December closing high. 

Per my comments in mid-December and again last week, small-cap equities, as represented by the RUT and the iShares Russell 2000 ETF (IWM--215) represent the biggest area of opportunity, with respect to the short-covering potential in these names relative to their larger-cap counterparts.

On that note, and for what it is worth, I noticed that a trendline that I have drawn through higher lows on the RUT from March through August 2020 is sitting around 2,120 -- the site of Friday’s low. In late August, the RUT broke below this trendline, preceding months of underwhelming performance. The RUT moved above this extended trendline earlier in the month, which could be signaling an accelerated advance in the weeks ahead and could be driven by short covering.

January 24 MMO Chart 2

At risk of sounding like a broken record, there is a lot of optimism among market participants, and the optimism is growing. For example, the weekly survey from the National Association of Active Investment Managers (NAAIM) showed the second highest reading of all time, with respect to participants’ equity exposure. 

Furthermore, the 10-day, equity-only, buy (to open) put/call volume ratio hit an extremely low reading of 0.32 last week for the third time since early September.  When this ratio hit 0.32 on September 2, the SPX was trading nearly 10% lower three weeks later. The ratio hit an extreme low of 0.32 again on December 17, and the SPX was flat three weeks later. It remains to be seen what will follow this time after another 0.32 reading last week. As you can see on the chart below, a 0.32 has been the floor in this ratio in recent months and marks an all-time low since we have been tracking.

January 24 MMO Chart 3

The optimism on display remains the biggest risk – are we on the verge of a correction like that of September, or another consolidation like we saw to end 2020?

From a technical perspective, the opportunity is clearly playing the market’s momentum, which is higher. Investors should do so with the sentiment-based risk in mind, whether that means taking advantage of cheap options to hedge long stock positions or buying call options in lieu of stocks to reap the leverage that options afford you, which allows for less money at risk. In other words, the playbook has not changed from prior weeks.

Finally, in the event the momentum does continue higher in the weeks or months ahead, I spent time looking for where the next real big hurdle for the SPX might be as we progress into 2021. As we are in uncharted territory, one cannot use past highs or lows as a point of reference. 

Therefore, I used a monthly graph since early 2009, or the financial crisis bear market low, as a point of reference. The chart below is likely one that long-time readers of this commentary have seen before. 

The horizontal lines mark levels that coincide with 2x, 3x, 4x, 5x and 6x the 2009 closing low. Note that in all instances, the SPX either hesitated for a lengthy period or experienced significant drawdowns immediately after touching these corresponding levels relative to the 2009 closing low. While I may be getting ahead of myself, the 4,056 area is the next big level to watch from this perspective, as it is six times the 2009 closing low. With the SPX 5.5% below this level, there is room to run before this next big hurdle comes into play.

January 24 MMO Chart 4

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

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