2 Indicators Pointing at Potential Volatility Ahead

The SPX channel depends on a "glass half empty" or glass half full" mindset

Senior Vice President of Research
Apr 8, 2024 at 8:39 AM
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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 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. ”

          -Monday Morning Outlook, April 1, 2024

If you have been following this commentary over the past few weeks, I have been quantifying the momentum backdrop we have seen in the stock market -- measured by the S&P 500 Index’s (SPX – 5,204.34) impressive rise since late October -- in addition to potential points of resistance, such as the level that is exactly 10% above last year’s close, or 5,235.  

Per the chart below, that area indeed came into play as resistance. Additionally, a bull channel began to become evident. I have mentioned the 30-day moving average as well, which contained the mid-January low. I find this interesting because it is not on the radar of most technicians, who focus on the more popular 20-day moving average. 

When assessing last week’s price action, in a week that saw Federal Reserve funds futures participants push the odds of an interest rate cut in June from slightly more than a coin flip to slightly less than coin flip, one can either take a “glass half empty” or “glass half full” approach. 

The former refers to the break of channel support on Thursday, which was attributed to a Fed president (who is not a voter in the monetary policy setting committee) floating the idea of no rate cuts this year. In fact, Friday’s intraday high at 5,225 was at the bottom rail of this channel. 

The “glass half full” approach points to the SPX holding -- at least for now -- the 30-day moving average (at 5,160), a trendline that marked a solid buying opportunity in January.

MMO 0408 1

This channel break is noteworthy because it could be suggesting that, at the very least, momentum has slowed. If the SPX quickly makes a bold move above the bottom-rail of the channel, it will confirm the 30-day moving average hold and give bulls renewed hope for more pain in the weeks ahead for bears.

Coincidentally, the bottom rail of the channel begins the week at 5,235, which is a level that coincides with 10% above the 2023 close. This channel ends the week at 5,271, which means a new high could be achieved this week, even with the SPX below the bottom rail of the channel. 

Bulls should also take note of the CBOE Market Volatility Index’s (VIX – 16.01) move above 15.40, which is half the 2023 high and an area that has marked multiple peaks this year. With two closes comfortably above 15.40, be open to the possibility that the VIX is hinting at higher volatility ahead, which could mean coincidental weakness in equities. 

MMO 0408 2

 

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. ”

          -Monday Morning Outlook, April 1, 2024

In last week’s commentary, I noted the short interest build that occurred in the first half of March. On the surface, this is bullish. But as I noted last week, if weakness in the market is in the cards, the shorts could become more aggressive and therefore add to selling.

On one hand, depending on how shorts react, they could use last week’s decline to cover losing positions, keeping pullbacks mild-natured. Or they may wait and look for opportunities to feed on additional weakness, as witnessed in 2022.

Something that intrigued me last week was Thursday’s candle, which happened on the day the bottom of the bull channel was breached. It was a bearish outside day, in which both the high and low were above the prior day’s high and low, with the close below the prior day’s low. 

In fact, the SPX opened more than 0.5% higher that day and closed lower by over a percentage point. In other words, it covered a big distance from the open to the close.

I asked Rocky White, our Senior Quantitative Analyst, to investigate prior instances of this happening. Using data since 1998, he found this to be a rare occurrence, with only seven prior events and the first happening in 2008.

The good news is this signal is not overwhelmingly bearish, but the bad news is that it does hint at volatility ahead, as the VIX is currently suggesting. Note that in the five, ten, and 21 days after the SPX opens by 0.5% or higher, it closes more than one percentage point lower relative to the prior day. The average move higher is greater the average in these periods, but the average move lower is also greater than the average for these periods. 

As such, if you are trading in these time frames, be open to unusually large moves higher or lower. With Fed minutes due out this week, there could be additional volatility. But for bulls, the good news is that the last time a candle occurred with the market near all-time highs was December 2021. The market was higher by four percent five and ten days later, and higher by nearly 6%, using a one-month measuring period.  

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

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