Digging Deeper Into This Historic S&P 500 Weekly Pattern

This year has also broken intermarket relationships in rarified forms

CMT, Senior Market Strategist
May 22, 2022 at 5:46 PM
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The S&P 500 Index (SPX – 3,901.36) closed negative for the seventh consecutive week, which is only the fourth time in history that the SPX has been negative for this many successive weeks or more since 1950. Previous instances were May 1970, March 1980, and March 2001. What has the market done after this has happened? It has produced bullish results in all three samples on a three-month basis and has produced forward returns of +7.27%. Two of the three instances have even produced +30% returns over the next year, but 2001 was a meager +0.22%. The thing is, it’s only a sample size of three, which is far from significant, so we can’t bet our hats on similar outcomes.

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This year has also broken intermarket relationships in rarified forms. Typically, we expect risk-off assets to help insulate investors as risk-on assets fall. This has not been the case, though. Junk Bond/Treasuries relationship broke out, which is traditionally bullish and has been a strange phenomenon during the market route. Bonds, in general, have sold off with stocks, and the gold standard 60/40 portfolio allocation advisors use is down -14.89% -- barely insulating mom and pop investors from the broad equity sell-off.

Speaking of gold, the inflation hedge we all assumed would protect us from this exact inflationary environment is only up +0.74% year-to-date. Indeed, that is outperforming equity indices, but that is not what one expects from the glimmering rock that is supposed to be the go-to inflationary hedge. Many growth stock darlings of 2020 started to crack in 2021, and now many of them are down -60 to -90% off their highs, so the pain is real. What might be most surprising is that the S&P 500 is yet to move into official bear market territory as we have yet to close -20% below the highs in the SPX – although we did touch the level intraday on Friday. Right now, officially, only the Nasdaq Composite (IXIC -- 11,354.61) can hold that title.

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“While the above risks of increased shorting and/or continued outflows from equity funds is real, the SPX is now trading around its 24-month moving average. Major buying opportunities have occurred here over the years, but you should emphasize monthly closes when using this (and other) monthly moving averages as a guide to identifying potential risk and reward.

As I cautioned in late March, if the SPX experiences a monthly close below its 24-month moving average, it has a tendency to experience additional selling, with the 36-month, or three-year, moving average marking some, but not all troughs (2011 and 2018 are the most recent examples).”

 - Monday Morning Outlook, May 14, 2022 

With all of this said, equities remain at a pivotal point since our last conversation where we could rally or fail to take the next step lower. The SPX found support around -20% of this year’s closing high on Friday. However, it’s still holding below the trendline connecting January and February 2022 highs and failed to close above it on Friday’s vicious snap-back rally. Still, it’s trying to put a double bottom in, and a break above that trendline would likely give the market legs to the 4,156 horizontal resistance level. Below 3,840, we need to be careful as it’s becoming a major pivot on the short-term chart. Furthermore, if 3,800 were to break, we have a good chance of reaching the 36-month moving average we’ve been talking about, which just so happens to align near the June peak put for the SPDR S&P 500 ETF Trust (SPY – 389.63) at the 360-strike level.

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Many pundits have stated that the market can’t bounce until Treasuries find a bottom. Well, it just might have with a confirmation candle this past week. The 20+ Year Treasury Bond ETF (TLT – 118.51) might have seen a bottom near the 2018 Christmas Eve sell-off, where the Fed eventually flinched in its previous rate hiking cycle. That’s the good news; the bad news is bonds finally started acting as a risk-off asset again. While this can help growth stocks out in the short-term as it could signal rates have gotten ahead of themselves and need to fall, I wouldn’t be using this as my all-clear signal to be long equities as the two assets are typically inversely correlated except for goldilocks periods we’ve experienced in the market. In my opinion, this marks an inflection point where traders and investors are now taking recession risks seriously.

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“The most recent option activity on VIX futures options should be welcomed by bulls, at least over the short term as one would expect equities to rally. That is, if this group is correct once again about the direction of volatility in the near term.”

 - Monday Morning Outlook, May 14, 2022 

Despite some large intraday market moves this past week, volatility surprisingly remained dampened, and VIX call buyers have yet to fully re-emerge after last week’s expiration per the 10-day Put/Call ratio, only climbing this past week slightly. My inclination is that call buyers are waiting for an equity rally before trying to pounce on the volatility trade again. With the Cboe Market Volatility Index (VIX – 29.43) below 30 now and below the trendline that Todd Salamone, our Senior V.P. of Research, has been watching, we have the potential for a short-term rally if volatility can continue to cool off.

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Additionally, sentiment indicators across the board are flashing buy signals. These work great in bull markets to mark buying opportunities as signals that can be actionable in a short amount of time, but in bear markets, even unofficial ones, they act differently. For instance, the AAII Sentiment reading for Bears fell but still came in at 50.4%, which is in the 97th percentile of all readings. Furthermore, the 4-week moving average of the AAII Bears has pushed above the 50% level to 52.92% and an area of readings last seen during the 2008-2009 Great Financial Crisis, where we chopped around at these higher levels for almost a year. The point is sentiment indicators can remain primed and ready longer as investors anticipate bounces only to see failures. So, we need to get a catalyst or a technical level to permit us to get long bear market rallies.

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However, we do have the SPX Components 10-day buy-to-open put/call ratio currently at 0.81 and working its way back near the 2020 peak during the pandemic crash, potentially giving us an opportunity to catch a bear market rally if we can get a rollover to unwind some of the bought-to-open put contracts’ open interest. This is still a far cry away from levels we saw in 2008-2009, but if the bear is just getting started, it might just need a relief rally before spiking to past levels seen in significant market downturns.

Investors and traders have been conditioned to buy the dip. With conversations I’ve had recently, it doesn’t feel like that has changed. I haven’t felt the panic or capitulation one would like to mark a major low. So, even though we have a contrarian sentiment setup for a bear rally, we need to heed caution in calling an ultimate market bottom. Play the rally if we get technical permission above the trendline we discussed earlier but be aware that market liquidity has tightened, and valuations remain above median levels. We could just as easily break below crucial support levels and experience another swift down move to support areas mentioned since bears don’t have many reasons to cover at this juncture. Corrections of this magnitude often extend lower than we expect, so staying nimble and trading what the market gives you is crucial at these moments until we get an all-clear signal.

Matthew Timpane is a Senior Market Analyst at Schaeffer's 

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