How to Play Another Possible S&P 500 Pullback

We're approaching the one-year anniversary of the Federal Reserve adopting a hawkish stance

Senior Vice President of Research
Nov 28, 2022 at 8:41 AM
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“…there is work to be done as potential longer-term resistance levels come into play even if the SPX moves above the 4,000-millennium mark… the declining 200-day moving average currently resides at 4,067, which is 13 points below where it was going into last week’s trading. And the trendline connecting lower highs since the SPX’s all-time closing high in January comes into this shortened holiday trading week at the round 4,100-century mark and ends the week in Friday’s half-day session at 4,090. This trendline and the 200-day moving average acted together in marking the August intraday high at 4,325, implying these areas are worth putting on your radar as potential resistance if the SPX moves through 4,000-resistance in the days or weeks ahead.”

            - Monday Morning Outlook, November 21, 2022

It was good news for the bulls last week, with the S&P 500 Index (SPX – 4,026.12) pushing above resistance at the 4,000-millenium mark. The three-successive daily closes above this key level occurred for the first time since mid-September, when a bearish “island reversal” pattern around that time hinted at bad things to come.

The closes above 4,000 occurred even as market participants were presented with more headlines from multiple Fed governors discussing their outlook on monetary policy. The good news is, the message remained essentially the same from the prior week, implying that there were not any huge surprises. As I did last week, using data from www.CMEGroup.com, I compared how fed funds futures players viewed the path of monetary policy from the week before. There was no change, as they assigned roughly a 50/50 chance that the fed funds rate would be between 5.00% and 5.50% after the March 2023 meeting.

Plus, Covid-19 made headlines again, with cases mounting in China, which had just begun to back off its restrictive “zero-Covid” policies in recent weeks. The rising cases spurred government officials to suspend schools, lock down universities, and ask residents to stay home for five days.

This week, we approach the one-year anniversary of the Fed announcing its intent to move from an accommodative to more restrictive policy, which occurred on Nov. 30, 2021, which is known as the date of its latest pivot.

The SPX closed at 4,655 the day prior to this announcement. Since then, beginning in March, six rate hikes have occurred, and we are going into this week almost 14% below the index’s close one year ago when we were warned by the Fed that its accommodative dovish policy was about to change.

Moreover, the SPX is 7.5% below its mid-March close on the day of the first rate hike, but above levels it was trading at after the past four rate hikes.

mmo chart 1 nov 27

On the charts, however, there is work to be done. The declining 200-day moving average that I discussed last week is now sitting at 4,057, just 31 points above Friday’s close. And the trendline connecting lower the January high, March peak and August high comes into the upcoming week at 4,087 and ends the week at 4,074. These will be important levels to have on your radar as we move out of November and into the final month of trading in 2022.

But bears beware, there is potential support not far below current levels if sellers come in at or below the levels of potential resistance described above. I see the area between 3,900 (July breakout level above trendline connecting March-June highs and then support/resistance on multiple occasions since) and 3,950 (breakdown level from trendline connecting higher lows June through early-September) as the bulls first line of defense.

Plus, a steep trendline connecting the October and early November lows comes into the week at 3,913 and ends the week at 3,967, which helps firm up this area of potential support.

With the above levels in mind, I find it interesting that the CBOE Market Volatility Index (VIX – 20.50) closed at 20.50 on Friday, its lowest level since mid-August, which is where it was at ahead of the mid-August decline when the SPX failed to overtake its 200-day moving average.

The obvious risk is repeat of that occurring if sellers take control into year end. As such, if you are long equites, this might be a good time to hedge with index or ETF options, with the VIX at a multi-month low and a plethora of economic data due out this week, including readings on consumer confidence this morning. Later in the week we get another look at employment data, personal income, and spending and PCE price data, all of which could be high impact events.

Per the second chart below, VIX futures call buying relative to put buying is high. These option buyers, albeit not perfect, have historically had a good track record, which may be another reason to consider hedging a long portfolio ahead of a slew of economic data due out during the next two weeks and potential technical resistance levels immediately overhead. 

mmo chart 2 nov 27

mmo chart 3 nov 27

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

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