New Hurdles Emerge For Surging SPX, NDX

Short interest and equity put options remain at elevated levels

Senior Vice President of Research
Feb 6, 2023 at 8:51 AM
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The month of January 2023 closed with a 6% gain for the S&P 500 Index (SPX—4,136.48) and more than a 10% gain for the Nasdaq-100 Index (NDX--12,573.36).  It was a mirror image of last year and thus welcome price action for bulls, who suffered through losses of 5% and 1%, respectively, on the SPX and NDX in January 2022. The January losses preceded year-end losses in 2022 of 19%for the SPX and 33% for the NDX.

The tech-heavy NDX advance is especially noteworthy, as the technology group was one of the more hated sectors coming into 2023. Not only were the double-digit NDX gains impressive, but during the month the NDX surged above a trendline connecting all major highs since late-December 2021 and above the important 12,300-century mark, which marked a key resistance level from September-November 2020 and a notable support level in March 2021.

For more on the historical implications of “As goes January…” for the rest of the year, please see the commentary posted last week on our web site by our Senior Quantitative Analyst, Rocky White, entitled, “Putting the January Barometer to the Test.”

Now, the September closing high at 4,010 and the December intraday highs at 4,100 mark the area where another set of sellers could surface, at least in the short term, amid a technical backdrop that has improved weekly since the beginning of 2023…”

            -Monday Morning Outlook, January 30, 2023

During the course of the SPX’s January rally, each week’s theme has been one major resistance area taken out, and another in immediate view. That was the case last week, on the heels of positive reactions to tame employment cost index data and Federal Open Market Committee (FOMC) Chairman Jerome Powell’s remarks after the FOMC raised the fed funds rate by 25-basis points on Wednesday.

The SPX pushed potential resistance in the 4,010-4,100 area during the advance. But after payrolls data came in much larger-than-expected on Friday morning, it pushed fed funds futures traders to double the probability to 60% from the day prior that the fed funds rate will be between 5.00-5.25% by the May FOMC meeting. Stocks declined on expectations the Fed will follow through with its projection that the fed funds rate will be above 5.00% at some point this year.

After reaching an overbought condition for the first time since August going into Friday’s trading, according to its 14-day Relative Strength Index (RSI), the SPX declined from the 4,150-4,160 area, which was not a huge surprise. For example, 4,150 represents a 50% retracement of its all-time record high in January 2022 and the October 2022 low, and the index hesitated in November at 4,000, which was a 38.2% Fibonacci retracement of those same highs and low. Moreover, 4,160 represents a round 10% rally from the late-December closing low at 3,783, a nice profit-taking level for anyone anchoring to those lows.

For what it's worth, the SPX 4,225 level is a round 10% above the 2022 close of 3,839 and could have short-term significance too. Just as the level that coincided with 10% below the 2021 close acted as support in the first quarter of 2022 and resistance in May and August 2022, the level that corresponds with 10% above the 2022 close could have equal importance if tested in the days or weeks ahead. I should also mention that the 24-month, or two-year, moving average resides at 4,206, cementing the fact that the SPX 4,200-4,225 area becomes the next potential resistance level to overcome. Time will tell if this is just another speed bump, or major pivot area.

SPX Daily 200-Day

Overhead speed bumps aside, continue to maintain a fairly aggressive bullish view on equities, as sentiment factors I have addressed during the past month -- extremes in negative sentiment prior to several technical breakouts to the upside  -- favor the bulls. As the negative sentiment is unwound, it becomes a supportive factor for the market, unless and until traders and investors have reason to no longer unwind bearish views.

Specifically, we have observed outflows from equity mutual funds and exchange-traded funds in the months leading up to the breakouts, which represent potential sideline money that can come back into equities. Additionally, short interest on SPX components recently hit multi-month highs, and with every uptick in the market, more and more shorts are feeling pain and thus are inclined to cover. Finally, equity option buyers recently displayed more pessimism on SPX and NDX components relative to prior historical peaks in pessimism. As they buy less calls relative to puts, this becomes another options-related supporting factor.

“…option buyers are in the middle of unwinding a multi-year extreme in negativity on individual stocks. This is evident by the direction of the 10-day, equity-only, buy-to-open put/call volume ratio on SPX components. Note in the chart below that it is declining from a record reading since we have been tracking. This ratio has made a series of higher highs and higher lows since the SPX’s peak, so I would like to see the ratio move below its prior low to confirm that the unwinding of fear in this group is for the long run.”

          -Monday Morning Outlook, January 30, 2023

In fact, per the underline in the excerpt above, and per the graphs below, the 10-day, buy (to open) put/call volume ratios on both SPX and NDX component stocks has moved below its prior low, which potentially signals we are in a longer-term bullish environment. Note that these ratios trended higher, with higher highs and higher lows, throughout 2022.

If indeed the highs in these respective ratios are in, and the ratio behaves like that after they hit peaks in early 2020, the stock market may be in the early stages of a powerful rally like that which occurred from March 2020 before hitting a speed bump in September 2020. The SPX hit a low of around 2,200 in March 2020 and was trading at a high of 3,500 in August, a 60% rally off the Covid-driven low.

But before getting caught up in such potential bullishness, identify levels that would cause you to lighten up on your bullish outlook. The first is a move below 3,970, which is the breakout level from the trendline that connected all major lower highs in 2022. Lighten up further on moves below that extended trendline, which currently resides just below the 200-day moving average. Finally, the 3,900-century mark is another key level of support that, if violated, should be reason to reign in your bullish views.

SPX 10day pc

NDX 10day pc

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

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