S&P 500 Could See Bullish Implications from Ratio Rollover

A rally stronger than even the most bullish anticipate, could emerge

Senior Vice President of Research
Jan 17, 2023 at 8:35 AM
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“...readers are very familiar with the importance I have assigned to the 3,900-century mark, the site of the July breakout above a trendline connecting lower highs from March through June, and then a support level in September and resistance level in November... Even if 3,900 is taken out, the area between 3,920 and 3,940 resides just overhead. The latter is the site of a breakdown below a trendline connecting higher lows from mid-June to early-September, with the breakdown occurring in mid-September.”

          - Monday Morning Outlook, January 9, 2023

“...even if the SPX recovers from this monthly close below the 36-month moving average, remember the trendline that has connected all major lower highs in 2022 as being a point of long-term resistance. The trendline comes into the new year at 4,009 and will be at 3,940 at the end of this month.”

          - Monday Morning Outlook, January 3, 2023

Last week, the latest S&P 500 Index (SPX – 3,999.09) surge put the index in a similar situation to those mentioned in the excerpts above. In an encouraging development for bulls, the SPX rallied above resistance at the 3,900 and 3,940 levels, on the heels of a positive reaction to the December consumer price index (CPI) report.

The reading sent interest rate hike expectations lower. For example, fed funds futures traders are now assigning a 5% probability of the fed funds rate to be between 5.00% and 5.25%, after the March Federal Open Market Committee meeting (as of Friday’s January 13 close). They assigned a 20% probability it would fall in this range just one week prior.   

However, the SPX again enters the week facing potential resistance, even after other resistance levels were taken out. For example, the index comes into the holiday-shortened trading week in the vicinity of the major trendline that has connected all major lower highs since its peak in early January 2022. This trendline begins the week at 3,980 and will be sitting at 3,970 on Friday.

Additionally, the round 4,000-millenium mark, which was the close prior to a break below a trendline connecting the October and November lows, could act as resistance. Just above lies 4,020, which is the SPX’s close on the day prior to the December rate hike, and the site of its November high.

MMO 0117 1

A breakout above this trendline could lead to a 10% to 12% rally …. This might suggest putting a little money to work..… another encouraging factor to consider is the short-term bearishness among traders…  the 10-day, buy-to-open put/call volume ratio on SPX components surged above the March 2020 level... This implies that an unwinding of this negativity is more than enough to push the SPX above the various resistance levels.”

          - Monday Morning Outlook, January 9, 2023

Sentiment is not something that you see on traditional price charts. Nevertheless, I observed on Twitter short interest is rolling over from multi-month highs and noted the positioning of equity option buyers in last week’s commentary. A breakout above these resistance levels would catch many on the wrong side and have bullish implications. In fact, a rally stronger than even the most bullish anticipations could emerge.

Consider that the ratio of equity put buying to call buying on SPX components and Nasdaq 100 Index (NDX – 11,541.48) components just rolled over from levels that were above the early-2020 Covid highs, implying short-term traders were recently more bearish than in March 2020. Rollovers from extremes in this ratio usually have bullish implications, at least in the short term, and possibly in the longer term, as you can see in the charts below.

MMO 0117 2

MMO 0117 3

The rollover in these ratios could have longer-term bullish implications for the market if they continue lower, and the next lows in the ratios are below the respective previous lows. As it stands now, both the SPX and NDX component buy-to-open put/call volume ratios have been making higher highs and lower lows. This is indicative of a long-term build in pessimism that has created only short-term buying opportunities within the bearish market trend.

With the above concept in mind, there is not exactly a bell that rings at troughs, so the jury is out as to whether October was a major low or simply a bounce in a bear trend. Amid this sentiment backdrop, you can increase equity long exposure, but be ready to decrease it if the market slips back below the December lows in the 3,750-3,800 area.

It is also January expiration week. Given the market’s rally, and unlike many other months in 2022, we are not at risk of an options-related selloff due to big put open interest strikes just below broad market exchange-traded funds (ETFs) and indices that tend to act as magnets.

The only notable is that the 390- and 400-strikes on the SPDR S&P 500 ETF Trust (SPY – 398.50) have a decent build in both call and put open interest, which means pinning action could occur around these strikes as Friday expiration nears.

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

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