Could Investor Pessimism Have Reached Its Peak?

Technology investors should stay the bullish course

Senior Vice President of Research
Oct 18, 2021 at 8:50 AM
facebook twitter linkedin


With standard October expiration on Friday and a huge build-up of put open interest at the 400-430 strikes, the risk of a delta-hedge selloff increases if the SPDR S&P 500 ETF Trust (SPY – 437.86) breaks 430, equivalent to the SPX hitting 4,300 in the upcoming days. If the SPY remains above these put strikes, there will be supportive expiration and short covering related to that put open interest, which is a plus for bulls.”

          - Monday Morning Outlook, October 11, 2021

October expiration week got off to a dicey start, but as the saying goes: “Sometimes it isn’t how you start, it is how you finish.” After the removal of some uncertainty regarding the Federal Open Market Committee (FOMC) meeting minutes, mixed reports on inflation, strong retail sales data, and positive earnings reports from some of Wall Street’s biggest banks, the S&P 500 Index (SPX – 4,471.37) finished with a weekly win. 

In fact, the SPDR S&P 500 ETF Trust (SPY – 445.87) low was $431.54 mid-week, never breaking below the 430 strike, which could have induced further selling. Buyers stepped in after a benign producer price index (PPI) followed a worrisome consumer price index (CPI), and the unwinding of short positions associated with expiring out-of-the-money SPY put open interest likely drove stocks into Friday’s close.

As the technical backdrop has become less orderly in terms of buy-the-dip, we are seeing evidence of pessimism growing, a condition that is necessary for a bottom. But in our experience using sentiment indicators, it is not only the absolute level of sentiment measure, but also the direction that the sentiment measure is heading. In other words, the most bullish conditions occur after a relative extreme in pessimism is achieved, and there is evidence that such pessimism has climaxed.”

          - Monday Morning Outlook, October 4, 2021

We are now seeing evidence of pessimism climaxing. The graph immediately below displays the 10-day, buy-to-open put/call volume ratio on SPX components. Note the small rollover from a climactic high, which have typically preceded bullish market conditions. 

Moreover, while the Nasdaq-100 Index (NDX – 15,146.92) component 10-day, buy-to-open put/call volume ratio has not yet rolled over, bulls might take some solace in the fact that, amid less technical deterioration than the SPX during the past decline, this ratio is around levels that have marked peaks multiple times in the past three years.

Weekly sentiment surveys are also indicating that pessimism may have climaxed, with the percentage of bullish advisors in the Investors Intelligence survey rising from 40% to 42%. Meanwhile, the American Association of Individual Investors (AAII) saw a bullish move from 26% two weeks ago, to 38% last week.

MMO 1018 1

MMO 1018 2

From a technical perspective, bulls should be encouraged by developments for the SPX and NDX. After multiple daily lows from mid-September into early-October at the round 4,300-century mark, the SPX has rallied above two potential resistance levels.

The first was from a trendline connecting lower highs since the early-September peak, with Thursday’s breakaway gap above this trendline at 4,392, cementing this accomplishment. This may have encouraged additional buyers, who pushed the SPX back above its 50-day moving average at 4,436, via a runaway gap at Friday’s open.   

A first level of support would be the SPX filling Friday’s gap, which coincidentally would be a retest of the 50-day moving average. Additional support would come from the trendline connecting lower highs since September, which begins the week at 4,380, and ends the week at 4,358, which is within five points of the close ahead of Thursday’s breakaway gap. 

The SPX comes into the week at a potential resistance area of 4,460, the level at which the break below the long-time bullish channel and 4,475 occurred one month ago. This is also double its March 2020 closing low. Just above these levels is another area of potential resistance at 4,500-4,507, with 4,500 being a round half-millennium mark, and 4,507 being the level that is 20% above last year’s close.

MMO 1018 3

 

…investors should proceed with more caution, since the SPX broke its buy-the-dip pattern that was visible for months. Plus, the Nasdaq-100 Index (NDX - 14,791.87) remains below the key 15,000 millennium level, which should have been supportive on a pullback. Now, there is risk of additional selling in the coming week to 14,370 and 14,000 or the lower rail of its 13-month bull channel...

          - Monday Morning Outlook, October 4, 2021

As I mentioned earlier in this commentary, the NDX did not experience the same technical deterioration the SPX saw during early October pullback, because the NDX did not break below a long-term bullish channel in place since September of 2020. Nor did the benchmark break below its 120-day moving average, which has usually marked troughs during this period.  

Because of this, I find the pessimism among option buyers on NDX components to be bullish right now, especially with the NDX closing back above the 15,000 last week. The current sentiment backdrop conflicts with the bullish trend, which ultimately has bullish implications. 

In July, when the NDX was making its first push at 15,000, option buyers were at their most optimistic in years, as measured by the extremely low level of the 10-day, buy-to-open put/call volume ratio on NDX components. While it took a while to play out, the NDX came back to visit this level just a few months later, after a brief push through 15,000. Now, with the NDX at 15,000 again, this same ratio is near the highs of its three-year range, indicating there is more firepower to push the NDX through 15,000 for more than a short period.

Technology investors should stay the bullish course, with the index in a bullish uptrend. Do not disturb long positions, unless the NDX breaks below its channel, which comes into the week at 14,500, and ends the week at 14,570.

MMO 1018 4

Much of the above discussion adds up to mounting evidence that a bottom is in for at least the next few months. Plus, the fact that the CBOE Volatility Index (VIX – 16.30) closed below levels of potential support adds to the bullish theory.

MMO 1018 5

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

Continue Reading:

Trader: Sell These 8 Stocks in 2021

1633101108

 




 
Special Offers from Schaeffer's Trading Partners