The Breakout Case for the Bulls This Week

The S&P 500 Index (SPX), Dow Jones Industrial Average (DJIA), and other benchmarks are charting familiar territory

Senior Vice President of Research
Apr 13, 2015 at 8:29 AM
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"...equity markets have had a tendency to become unstable during early stages of a rally above key round-number levels, until finally such instability around these areas disappears. Admittedly, it is the latter that generates complexity, as we have witnessed many instances in which these benchmarks eventually take out round-number resistance for good. But, as we saw last week -- not this time."
-- Monday Morning Outlook, March 30, 2015
"In the interest of keeping it simple, the short-term outlook continues to favor the bulls, with the SPX's 2014 close continuing to act as support in the near term."
-- Monday Morning Outlook, April 6, 2015

From a technical perspective, a theme that has been consistent during the past few weeks is using pullbacks to year-to-date (YTD) breakeven or round-number levels as buying opportunities, while caution (correctly) reigned on rallies to, or just above, key round-number millennium and century marks.

So, during the past two weeks, we advised that the probabilities favored the bulls, with benchmarks such as the Dow Jones Industrial Average (DJIA - 18,057.65), S&P 500 Index (SPX - 2,102.06), and NYSE Composite (NYA - 11,112.69) stabilizing after pullbacks around their respective 2014 closing levels, while the S&P MidCap 400 Index (MID - 1,534.96) simultaneously pulled back to the round 1,500 level.

As we move into April expiration week, we have come full circle, with major indexes such as the Nasdaq Composite (COMP - 4,995.98), DJIA, and SPX trading again just above or below major round numbers that have spelled short-term trouble in the recent past.

For example, COMP advances above 5,000 were quickly met with selling on two separate occasions last month. Since late December, sellers have greeted advances above DJIA 18,000. Moreover, selling soon befell the SPX after moving above the 2,100 century mark on two separate occasions last month, as the index continues to use century marks and half-century marks as significant pivot points amid its grind higher.

Daily SPX Chart since December 2014
Round numbers (horizontal lines) and YTD breakeven (dotted line) have been pivot areas in 2015

Daily SPX Chart since December 2014

The "simple" action for short-term traders would be to lighten up on long positions, or consider adding short positions to your portfolio. "Simple" has indeed trumped "complex" during these last few weeks as buying YTD breakeven support and selling round-number resistance has proven to be a profitable approach.

However, keep in mind that these round numbers have simply served as speed bumps amid a low-volatility, longer-term uptrend. In other words, selling pressure eventually subsides around the round numbers, punishing the shorts and rewarding the bulls.

In fact, short covering has produced a few impressive short-term rallies through round-number resistance, such as the fourth-quarter 2014 short-covering advance that occurred during earnings season and pushed the SPX through the 2,000 millennium mark.

As you can see on the chart immediately below, the shorts have built up positions to the highest level since March 2014, perhaps driven by dollar strength and the resulting downward earnings revisions. We discussed the potential positive implications of the lower earnings expectation bar in last week's commentary. So, at risk of diving into the more complex after "simple" has been working, the fact is that the current sentiment backdrop favors another earnings-related breakout above round-number resistance levels.

SPX with Total Short Interest since January 2013

SPX component short interest at highest level since March 2014 -- another short-covering rally during earnings season?

Next week will give investors a lot to digest, so it could be a headline-driven environment. The economic calendar is full, beginning with Tuesday's producer price index (PPI) and March retail sales. The number of companies reporting earnings will noticeably increase too, particularly in the financial group, with Wells Fargo (WFC) and JPMorgan Chase (JPM) kicking things off before the open on Tuesday morning. Investors will also be eyeing overseas developments, particularly central bank meetings in China and Europe. Finally, as we alluded to earlier, it is expiration week, with April options expiring on Friday, and CBOE Volatility Index (VIX - 12.58) April options settling Wednesday morning.

With that in mind, the 210 "call wall" on the SPDR S&P 500 ETF Trust (SPY - 210.04) is a level that we will be watching, as this equates roughly to the round-number SPX 2,100 that we discussed earlier. In an ideal world, sellers of the 210-strike calls and puts would like to see the SPY get pinned at 210 on Friday afternoon. Therefore, one scenario for next week is a lot of headline-inducing volatility around this strike, as it acts as a magnet when the SPY drifts too far above or below it. That said, a close above the 210 "call wall" at expiration would build upon the breakout case for the bulls.

SPY 4/17 Expiry Open Interest Configuration

SPY April Open Interest Configuration

Read more:

Indicator of the Week: Why April is a Good Time to Buy Stocks

The Week Ahead: Blue Chips in the Crosshairs

What This Election Year Means for Stocks

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