Yesterday's SPX Headwinds Could Be Tomorrow's Tailwinds

The SPX has two moving targets bulls would like to see get hit this week

Senior Vice President of Research
Apr 1, 2024 at 9:11 AM
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Amid a shortened trading week with the market being closed on Good Friday, the S&P 500 Index (SPX—5,254.35) eked out another weekly gain and has now advanced in nine of the past 12 weeks. Last Thursday also marked the last trading day of the first quarter, in which the SPX gained 10.2%. Meanwhile the Nasdaq Composite (IXIC—16,379.46) notched a 9.1% advance, the Dow Jones Industrial Average (DJI—39,807.37) moved ahead by 5.6%, and the Russell 2000 Index (RUT—2,124.55) trailed with a 4.8% gain. The DJI is now approaching 40,000 after moving above 30,000 in November 2020.

Despite the market’s closure on Friday, the Federal Reserve’s preferred measure of inflation, the core personal consumption expenditures price index, was released Friday morning. It came in as expected, with the core index rising 0.3% in February. The index was up 2.8% from a year earlier.

“…there must be a defined technical breakdown that suggests latecomers to the rally are feeling pain and therefore at risk of selling…the SPX is at a potential hesitation or pivot level. Due to the momentum, I’m more inclined to call this a potential hesitation point until I see evidence that the momentum off the late-October low is hinting at running out of steam, which I don’t see at this moment…the SPX approached 5,250, the top rail of a channel in place since late last year and early this year came into play. The good news for bulls, if investors anchoring to the 2023 close are no longer relevant, is that the top rail of the channel moves higher with each passing day. ”

          - Monday Morning Outlook, March 25, 2024

As noted as a possibility in last week’s commentary, there appears to be sideways action in the SPX 5,235 and 5,250 area, with the former level representing 10% above last year’s close and the latter the site of trendline resistance the previous week. As discussed in prior commentaries, some investors anchoring to last year’s close may be tempted to take profits at round percentage levels, which is why I note these levels when they come into play.

The top rail of the trendline resistance, which connects higher highs since the end of December, comes into the week at 5,310 and will be at 5,345 at the conclusion of this week’s trading. Implying from this vantage point, the SPX has more “breathing room” as we enter this week’s trading relative to the prior week, when the SPX was sitting right at this channel resistance.

With respect to levels of support to watch if sellers overwhelm buyers in the near term, I recommend focusing on two levels, both of which are moving targets.

The first is the bottom rail of the bullish channel connecting higher lows since mid-January, which comes into the week at 5,190, but will be at 5,225 on Friday. Another level of potential support is the SPX’s 30-day moving average, which is at 5,130 now and projected to be at 5,175-5,180 by week's end.

If these levels of support are broken to the downside, we would be at heightened probability of corrective-type action. But as I have been saying all along, this is not yet a market hinting at corrective action from a technical perspective. As such, continue to stay in tune with support levels.

SPX 6 Month Daily

A sense of prudence also prevailed as concern about a disconnect between earnings expectations and share prices have grown. Morgan Stanley and JPMorgan Chase & Co. strategists were the latest to warn it’ll be hard to justify lofty valuations if profit acceleration fails to materialize. We continue to see sentiment as stretched and think a US equity market pullback is overdue,’ said Lori Calvasina at RBC Capital Markets.

          - Bloomberg, March 24, 2024

“…’It just might come one day out of the blue. This has happened in the past, we’ve had flash crashes,’ Lakos-Bujos said in a webinar. ‘One big fund starts de-levering some positions, a second fund hears that and tries to re-position, the third fund basically gets caught off guard, and the next thing you know, we start having a bigger and bigger momentum unwind.’”

- J.P. Morgan’s chief global equity strategist, Dubravko Lakos-Bujas, as quoted in a March 24, 2024 Bloomberg article 

For example, “risk of disappointment in the near term, “priced for perfection,” ‘vulnerable to profit taking or consolidation,’ ‘rally running out of steam,’ ‘near term volatility in both rates and equities’ and a projection for SPX 3,500 is what I have seen from the strategist community. The negative outlook in the near term could mean that this rally persists longer than the collective opinions of this group.”

          - Monday Morning Outlook, December 11, 2023 

Amid the continued momentum in stocks, I am seeing the sentiment backdrop as more conductive to a rally relative to a few weeks ago, when several of our sentiment indicators were flashing optimistic extremes.

For example, on the anecdotal side, a few strategists weighed in with cautionary notes last week, as excerpted above. It reminds me of the warnings that strategists were sounding in late-November and December of last year as stocks rocketed off the late-October bottom. My takeaway is no different now than it was in mid-December when I addressed the cautionary alarms of the strategist community with the SPX 14% below Friday’s close. One day they may be right, but safe to say their collective timing has been way off the mark.

Money flows in the options market continue to hint at growing caution. Short-term option players emphasized puts, with put open interest growing more than call open interest last week on the just-expired March 28 SPDR S&P 500 ETF Trust (SPY—523.07) options. In fact, there were large put adds at strikes below the SPY’s closing low last week of $518.81.

SPY Late March Put OI

A couple of other sentiment indicators caught my eye too. Most notable is the change in total short interest on SPX component stocks after the exchanges released short interest data through mid-March. In the latest report, short interest rose 4% and has now increased 10% in 2024. A rise in short interest is a coincidental headwind, so the fact that stocks have rallied amid this headwind could have bullish implications. To the extent that shorts are feeling pain, they may be forced to cover, or at the very least, slow the pace of adding positions that bet against stocks. In other words, yesterday’s headwind could be tomorrow’s tailwind.

That said, there was a short interest build in the second half of 2021 as stocks rallied, and this preceded notable weakness in the market from the start of 2022 that lasted into the fourth quarter of 2022. As such, it is not a given that the market will soar to new highs amid this seemingly bullish backdrop.

Nonetheless, with total SPX short interest nearing a four-year high, one might not easily conclude from this chart that the market is rallying strongly and at all-time highs. In fact, there appears to be a health amount of skepticism, contrary to what some strategists are saying.

SPX Short Interest April 1

Finally, note in the chart below that option buyers on SPX component stocks have turned toward more put buying relative to call buying in the past two weeks, relative to the two weeks ending late February. This is evident by the big increase in the 10-day, buy (to open) put/call volume ratio on SPX components from 0.49 in late February to the current 0.63 reading.

With this ratio at its highest level in 2024, and in the context of a strong market rally, the contrarian takeaway is bullish. But should bets against the market and stocks continue to rise amid a breakdown of support, the bullish implications are no longer validated.

SPX 10day PC ratio

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

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