SPX "Uncle" Level Bulls Should Watch Now

Major support areas have yet to be pierced on the downside

Senior Vice President of Research
Jun 26, 2023 at 9:00 AM
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“…rather than get into game of what the Fed will do next or whether or not a recession is ahead, allow the market to guide you in your investment decisions…Indeed, pullbacks or hesitations from present overbought conditions is certainly a possibility... I don’t see a need to disturb your bullish positions unless and until the SPX declines below the 4,160 level, so use pullbacks as buying opportunities for now.”

          -Monday Morning Outlook, June 20, 2023

The S&P 500 Index (SPX--4,348.33) came into the holiday-shortened week last week in an overbought condition, per its 14-day Relative Strength Index (RSI), which was above 70 entering June 20. While an overbought condition can persist amid a consolidation or continued advance, it also isn’t surprising if a pullback like the one experienced last week emerges.

During the course of the week, investors digested better-than-expected housing data, followed by Fed Chairman Jerome Powell’s comments on monetary policy to Congress, in which he essentially doubled down on what he said earlier this month in terms of the Fed’s fight to bring down inflation not being finished, July being a “live” meeting for another increase, and the potential for two more rate increases by year-end.

While the housing data surprised to the upside, fed funds futures took Powell’s comments in stride, as expectations for a 25-basis point rate hike in July remained about where they were going into last week at just over 70%.

“…the same Wall Street strategists that were expressing considerable caution toward equities in April and May have not capitulated

          -Monday Morning Outlook, June 20, 2023

Major brokerage strategists continued with cautionary notes last week after a plethora of warnings the prior two weeks. A strategist from Wells Fargo warned that the tech rally at present is like that of 1999 and 2000, when tighter monetary eventually generated a sharp selloff in equities, particularly tech.

“… US stocks had the first outflow in four weeks at $5.7 billion… US growth had $3.7 billion of outflows versus $200 million of redemptions for US value... For sectors, financials had the biggest inflows while tech and energy had largest outflows

          -Bloomberg, June 23, 2023

With the SPX overbought last week as investors weighed more rate increases and the numerous cautionary flags waving from Wall Street’s elite, it is apparent that fund investors took heed and lightened up on equity exposure.

Such activity may have weighted on stocks last week, however, per a graph we put together using data from ICI.org, when combining exchange-traded fund (ETF) and domestic equity mutual fund flows, outflows have been the norm in 2023, which is another indication that while outflows are a risk from week to week, there appears to be more risk to bears of inflows, or “buying the dip” as long as major technical damage is not incurred in the weeks and months ahead. 

mmo june26 1

One may not be surprised by the fund flow data this year after I noted in last week’s commentary that short interest had increased by 8% on SPX components from late January into early June, and that short interest on Nasdaq-100 Index components is at its highest level since 2017 and up 16% from its recent February trough.  As such, pullbacks like last week could be viewed as an opportunity for those losing on short positions to cover positions that are losing, but not losing as badly as the prior week.

There are two potential support levels above the key 4,160 level to put on your radar if a pullback occurs in the days or weeks ahead:

  1. 4,375 - the March 2022 breakout level above a trendline that connected lower highs from January through February 2022, and
  2. The 4,290- 4,300 area - roughly 20% above the 2022 closing low and site of a trendline connecting higher highs since March

-Monday Morning Outlook, June 20, 2023

Per the chart below, the pullback last week did very little technical damage to the market, at least with respect to not moving back below former resistance at 4,160 or the 4,290-4,300 area.

That said, a technical risk is a repeat of March-June 2022 price action. Specifically, a rally above the 4,375 level in March 2022 followed by the April 2022 decline below 4,375, which preceded a significant two-month pullback. Bulls do not want this pattern to repeat itself. Such risk may warrant a hedge to your long portfolio as you buy stocks you like on the pullback. But as I stated last week, unless major support areas are pierced to the downside, particularly the 4,160 level, do not disturb long positions and/or consider using pullbacks as buying opportunities amid the doom and gloom warnings from strategists.

Yes, these strategists could eventually be proven correct and, as such, it is a good idea to have an “uncle” level or levels in which you reduce or gradually reduce long exposure. But as long as major technical damage is not done amid the cautionary notes, keep in mind that the upside from this caution is potential sideline money that could keep the uptrend intact longer than market participants anticipate.

mmo june26 2

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

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