Entry Point Looming for S&P 500 Bulls

The SPX tends to underperform immediately after two-month rallies

Senior Quantitative Analyst
Jul 19, 2023 at 8:41 AM
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Stocks have taken off in 2023, and especially in the last two months. The S&P 500 Index (SPX) is up over 9% since the middle of May, and it’s hard not to think some regression is due. This week, I’m looking at what the chances are for regression, based on historical two-month rallies. I’ll break down the historical data a few ways to fit the current environment, and I’ll look at how option traders might want to position themselves over the short term.

SPX Two-Month

Ripe for a Pullback?

The first table below shows how the S&P 500 performed after two-month rallies of at least 9%. The second table shows typical returns for the index going back to 1950. Stocks tended to be weak over the next month, with the S&P 500 losing 0.20% on average compared to usually gaining 0.73%. The underperformance was mainly due to a lack of upside after these rallies. Over half of the next one-month returns were positive and the average negative was only slightly worse than usual (-3.6% vs. -3.35%). The average positive return over the next month was only 2.62%, which is a lot lower than the typical average positive of 3.29%.

The good news is that the underperformance has tended to be short-lived. The three-month return after a signal has been positive, then at six months the returns have been similar to anytime returns.

SPX 9 Rallies

Still a Ways to Go

In these next two tables, I’m breaking down the 75 signals by how close the S&P 500 was to its all-time high. The latest signal occurred last Thursday when the index was still 6% off its high from early 2022. The first table shows the results when the S&P 500 was at least 5% off the all-time high, like now. The second table is when the index was within 5% of the high. The numbers are interesting and not what I expected.

In the short term, when the S&P 500 has tended to struggle, it has struggled even more when the index was significantly off its high, like now. The index has averaged a loss of 0.70% in these situations with less than half of the returns positive. In the longer term, however, the S&P 500 returns have been bullish in these situations. Six months after these signals, the S&P 500 has averaged a gain of 7.65%, with 80% of the returns positive. When these two-month rallies have occurred at or near all-time highs, the index has gained on average just 2.67% with 65% of the returns positive. Based on this, we could see a short-term pullback then a strong rally.

SPX 5 off

The Move For Options Traders

This last table shows the dates of the signals since 2017, along with the next month return for the S&P 500. I also show what option traders would have expected over the next month if buying a call, put, or straddle. The options assume they were at-the-money and expired in a month. You can see the last two times these 9% rallies occurred, the S&P 500 pulled back sharply over the next month. The index lost 4.53% and 8.12% over the next month after the last two signals. An at-the-money put option would have returned 112% and 332%

We only have these seven data points with the options return data, but it highlights the lack of upside which I mentioned above. In two of the three instances in which the index was up, the move did not cover the premium an option trader would have paid for an at-the-money call option. All three times the S&P 500 pulled back after these signals, it led to triple-digit put option returns.

SPX 2 Month Signals


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