S&P 500 Levels to Watch After Last Week's Fed Decision

Short-term technical bumps could reside immediately overhead

Senior Vice President of Research
Jul 31, 2022 at 11:30 AM
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“…the SPX broke out above the 3,900 level, which is the site of the trendline connecting lower highs from its March 2022 ‘false breakout” high…Might this indicate clear sailing ahead for the next few months, perhaps back to the 4,375 area? If so, it would be the same pattern as 2007-2009… Consider playing a move up to 4,375 on the SPX, which is 10% above Friday’s close… also assign a stop on closes back below the 3,800-3,900 area, scaling out of the long if the SPX closes back below last week’s 3,900 breakout level, and scaling out of the rest of the position if it closes back below 3,800. This would represent roughly 3% downside risk.”

Monday Morning Outlook, July 23, 2022  

For a week that was billed as one of the most important of the year, the bulls had the upper hand. For instance, one third of S&P 500 (SPX – 4,130.29) companies reported earnings. For those not locked into the pre-earnings season sentiment, the consensus heading into it was that stocks were vulnerable to that “final shoe” dropping, as many believed optimistic expectations were not in line with a dismal economic reality. But as we learned over the last week, this sentiment was likely factored into many, though not all, equities. 

Moreover, the Federal Open Market Committee (FOMC) meeting brought a 75-basis-point interest rate hike mid-week, giving investors something to ponder. Plus, Thursday’s second-quarter gross domestic product (GDP) reading revealed a second consecutive quarterly contraction, and sparked debate as to whether we are in a recession.

After the dust settled, bulls prevailed. But the week didn’t start out promising, with the SPX trading lower to an area just above the 3,900 level, that I highlighted as critical in last week’s commentary. However, by week’s end, the SPX pushed above the round 4,000-millennium level that briefly acted as resistance, and moved above the 4,033 area, which is a round 10% above the June closing low. 

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In last week’s commentary, I noted that if June was a key bottom, and the price action coming off the bottom is anything like that which followed the 2007-2009 bear market bottom, the 4,375 level is a reasonable target, and the market could be vulnerable to heavy selling. This would be repeating the corrective action in 2011, from a level that represented a “fake out” breakout, above a trendline connecting lower highs near the beginning of that bear market.

The 4,375 level is still achievable if fund managers, who have raised significant cash ahead of this rally, begin engaging again and equity option buyers continue to grow more optimistic after reaching climactic levels of pessimism.

Meanwhile, shorts who have built up positions on SPX component names so far this year (see chart below) to the highest level since late 2020 are likely not experiencing huge pain, even amid this latest rally. One has to wonder if they will begin throwing in the towel after earnings have not so far been the market’s undoing, and debate swirls as to whether Federal Reserve Chairman Jerome Powell’s comments after last week’s rate hike represented a pivot from an aggressive inflation-fighting policy. 

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Short-term technical bumps could reside immediately overhead, such as the June closing highs in the 4,160-4,175 region, where sellers who are looking for a second chance to de-risk may emerge. This was the area from which the SPX began a more than 10% decline in under two weeks.

If the SPX moves through this level, the next big area to overcome would be 4,290-4,300, which is 10% below its 2021 close. Note in the top pane of the SPX graph above that it has pinged mostly between levels that correspond to -10% and -20% year-to-date losses.

If you took on a more bullish posture last week, keep risk-reward in your favor by moving one of your stop levels higher to an SPX move back below 4,000, which is where you would consider taking some money off the table. Be extra cautious if the SPX moves back below its 3,900 breakout level. Meanwhile, there is still about 6% upside to your first target in the 4,375 area.

Finally, I noted in previous commentaries that Cboe Volatility Index (VIX – 21.33) futures call buyers are a risk to the bull case, as they have been pretty good at timing increases in expected volatility, in conjunction with sharp equity declines.

This ratio recently peaked and is now plummeting. However, amid the decline in this ratio, volatility is on the decline too, as equities surge unlike prior instances this year. To the extent that the VIX futures call buying represented fear ahead of the past week, a continued unwinding of this sentiment could have bullish implications moving forward.

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

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