Sentiment Shift Could Signal Market Top

Despite sentiment shifting among options traders, S&P 500 support held

Senior Vice President of Research
Mar 18, 2024 at 8:53 AM
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“… the VIX is sitting at trendline support using a series of higher lows since December 2023. The last two times the VIX touched this trendline, Jan. 23 and Feb. 9, the advance off the trendline did not generate what might be viewed as ‘ significant’ selling in the context of the trend, but the SPX was lower one week later…”

          -Monday Morning Outlook, March 4, 2024

In tracking the behavior of both the Cboe Market Volatility Index (VIX — 14.75) and the S&P 500 Index (SPX — 5,117.09) in the last two weeks, I thought it would be helpful to review what has happened and what is relevant now. 

The SPX was lower, albeit barely, one week after the VIX touched the trendline connecting lower highs since mid-December on March 1. Even two weeks later, using Friday’s close, the SPX is a little lower than that close. It was once again a signal that momentum was about to slow in the short term, even though another all-time closing high was achieved last Tuesday. The past two weeks can be best characterized as sideways movement in the SPX.

With the March Federal Open Market Committee (FOMC) scheduled for Wednesday, investors are not making any major moves, though beneath the surface, energy stocks, gold, and Bitcoin (BTC) are getting bid higher, while technology stocks retreat. After all, inflation data came in hotter than expected last week, and traders continue to expect a rate cut in June, a combination that investors view as good for commodities.

Despite volatility, as measured by the VIX advancing this month, there has not been a short-term technical breakdown in the SPX, which is still above the 5,000-millenium level as well as its 30-day moving average, which was supportive in mid-January when short-term price action looked similar to now. The 30-day trendline is currently sitting at 5,060, and is projected to be at around the 5,100-century mark this time next week, based on its trajectory.

SPX 30-Day MA March 2024

“…the Cboe Market Volatility Index (VIX - 14.71) came close to hinting at trouble ahead when it threatened to sustain a move through the January highs at 15.40, which is one half the 52-week high of 30.80. If the VIX moves through 15.40 again, I would view this as a caution signal for bulls, at least for the short term.”

            -Monday Morning Outlook, February 20, 2024

Last week, the VIX again flirted with the 15.40 level, which is half its 2023 high achieved just over one year ago. You can see the importance of this level in 2024 below. Continue to monitor the VIX, as a strong move through this level could signal that the momentum of the late-October low is ending and might suggest a period of market weakness.

As of Friday’s close, the VIX is not signaling major weakness, but there are sentiment indicators such as those Senior Market Strategist Matthew Timpane mentioned last week that point to a heightened pullback risk.

VIX Six Month Daily

Timpane mentioned the Investor’s Intelligence (II) readings showing an extreme in optimism. Money flows suggest optimism, too. For example, the five-day open interest changes on the expired SPDR S&P 500 ETF Trust (SPY — 509.83) March 15 options showed a bias for out-of-the-money calls, with the biggest five-day open interest (OI) change at the 522 strike.

Remember, such market participants had been showing a bias toward puts, or downside bets, since at least December. Could a sentiment shift from the same group be hinting at a top?

Per the second chart below, equity option buyers are turning cautious after a recent multi-month high in optimism, as is evident by the relatively low reading in the 10-day, buy-to-open put/call ratio on SPX component equities. When these market participants grow cautious after an extreme in optimism, the risk of an equity selloff increases.

These sentiment indicators are noteworthy, but will carry more weight and meaning if the SPX breaks below support levels mentioned earlier. With the FOMC meeting just ahead amid signs that traders are positioned for a rally, a hedge via an index or exchange-traded fund put might be a strategy that is viable to guard against growing sentiment-based risks.

SPY Open Interest March 2024

SPX 10-Day PC Ratio March 2024

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

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