Last week's comments from Fed Chair Jerome Powell sent the market reeling, though SPX technical support came into play during Friday's rally
“…The focus in the coming week will be Wednesday’s monetary decision by the Federal Open Market Committee (FOMC)… one group of option buyers that I am monitoring closely is option buyers on CBOE Market Volatility Index (VIX-13.81) futures… the decline in the VIX to near its 2024 lows has attracted call buyers anticipating or hedging against higher volatility and lower stock prices. Heavy call buying relative to put buying on VIX futures has tended to foreshadow higher volatility…in addition to the extremely low equity buy (to open) put/call ratio on SPX component stocks… it might be worthwhile to hedge long positions so you aren’t caught suddenly off guard.”
-Monday Morning Outlook, December 16, 2024
The various pieces in the excerpts above from last week’s commentary would have been highlighted for emphasis if I knew with 100% certainty what I know now.
We entered standard December expiration week with the final Federal Reserve meeting of 2024, equity option buyers on S&P 500 Index (SPX--5,930.85) components (typically dumb money) displaying extreme optimism, and option buyers on Cboe Volatility Index (VIX--18.36) futures (typically smart money) hinting at higher volatility ahead. From a technical perspective, however, the SPX wasn’t hinting at major trouble, thus I suggested a hedge to long positions might be worthwhile as a strong technical backdrop can become not as strong, or even extremely weak, lightning fast.
It was a recipe for a potential disaster for bulls and what transpired was a near 4% weekly decline at Friday morning’s low, with investors selling stocks after Fed Chairman Jerome Powell suggested that rates may not come down as quickly as anticipated because inflation was sticking around longer than the central bank expected.
Nonetheless, it caught many off guard judging by the market’s reaction. But after evaluating the equity market’s huge rally on lower-than-expected inflation data Friday morning and dovish remarks by Chicago’s Fed President -- who will be a voting member on the Federal Open Market Committee (FOMC) next year after replacing Cleveland's hawkish president -- the following can be asked:
- Since when has this Fed had a good track record at forecasting inflationary trends and anticipated policy moves?
- Will the perceived Fed pivot last week have a lasting negative impact on equity prices?
Taking a stab at question two, the SPX comes into the week below short-term levels of support that I identified last week, specifically the 20-day moving average that checked a pullback in mid-November. The index is also below the November 11 high that I suspected could be supportive after it was taken out earlier this month.
As such, the short term could be choppy, with this potential support now representing potential resistance looming overhead in the SPX 6,000-6,010 area. Plus, a new “B” on the chart below emerged last Wednesday that marks bearish “outside days.” Such candles foreshadowed short-term weakness in equities on multiple occasions this year. But Wednesday’s candle could be offset by Friday’s bullish “outside day” candle, as it looks very similar to the price action at the early September trough that formed a shoulder in the bullish inverse “head and shoulder” pattern that was completed later that month.
But with the mega-rally from the August lows, there are multiple layers of intermediate-term support that came into play last week from which the SPX rebounded with help from Friday’s “counter-catalysts” mentioned above.
For example, the mid-October high and mid-November low in the 5,875 level held the pullback. And Friday’s low was just above the 80-day moving average, which we monitor because it is not popular with traders but sometimes acts as support during the final stages of a flush when the more popular 50-day moving average is broken.
I haven’t discussed the 80-day moving average for a long time because it hasn’t had significance since April 2024 when it last acted as support and, before that, in August 2023 when it marked a short-term trough before September 2023’s cross below the 80-day moving average that triggered a sell signal into the eventual late-October 2023 low. In fact, the SPX closed the week above -- albeit barely -- its 50-day moving average that is sitting at 5,927.
If the SPX stays above last week’s lows in the 5,825-5,880 area, I think the bulls remain in control in the intermediate term. And even if that area is breached, the pre-election close at 5,780 could exert support, implying the bears have a lot of work to do before the intermediate-term uptrend can be called into question.
The VIX is worth watching for clues as well. Note in the graph below how last week’s peak occurred in the vicinity of double last year’s close and roughly double the multiple lows this year in the 12 area. I think bulls remain in firm control if the VIX stays below this area, as sellers of volatility may predominate rather than buyers of volatility that were present just before last week’s selloff.
As a side note, per the second graph below, a plethora of both SPDR S&P 500 ETF Trust (SPY--591.15) call and put options expired worthless last week, making SPY option sellers the true winner in last week’s expiration-week pullback.
And don’t forget, it has been and remains a highly shorted equity market this year and going into 2025. It is possible that short covering keeps pullbacks like last week in check as shorts run for cover from losing trades.
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