What a week — between NVIDIA Corp (NASDAQ:NVDA) earnings and the Jackson Hole Economic Symposium, we saw violent intraday swings that whipsawed investors through a volatile roller coaster. However, this is not highly unusual for August, which is a historically choppy and hard-to-predict month for equity returns. Furthermore, this price action often persists through the third quarter, so let’s look at where we stand and what to make of it.
“Looking ahead to next week, I see potential resistance around 4,465 – 4,470, or the area that represents double the March 2020 closing low and the trendline that connected the March and May lows…”
– Monday Morning Outlook, August 21, 2022
Right now, the S&P 500 Index (SPX – 4,405.71) is seemingly stuck between a rock and a hard place. While the SPX attempts to steady itself off the 80-day moving average after breaking through the lower rail of the price channel, this past week’s rejection on the back of NVDIA’s earnings came right near the level we outlined last week — double the March 2020 closing low and the converging 20-day and 50-day moving averages. Now, we have a bearish crossover of the moving averages as we head into the final week of August. The good news is that in the past 10 years of data, stocks are higher 67% of the time two months later, by an average return of +1.32%. The bad news is that we likely will endure more whipsaw market action until we resolve out of the range.
The range currently resides between 4,325, the August 2022 peak, and the 4,600 area, which marks the 2022 breakdown and subsequent resistance levels from February and March 2022. However, this range could extend lower if the 4,325 level is breached, confirming the head-and-shoulder pattern. It could also send equities to test the 4,195 breakout level from the February and May 2023 peaks that coincide with the fast-approaching 200-day moving average, the 50% Fibonacci retracement level from this year’s March lows and July’s peak, and the longer-term lower rail of the current price channel.
Additionally, markets officially enter September on Friday, which is historically the worst month for equities over the last 10 years, where it’s been down 60% of the time by an average of -1.5%. One thing to remember is that this is for the whole month. When we look under the hood in pre-election years since 1991, most of the damage comes post-September options expiration (OPEX). While investors fret about the negative headlines from this, we typically enter a bullish period starting at the end of August, where stocks rise on average through September OPEX.
Also, as we mentioned last week, equities might find a floor if rates find resistance at the October 2022 peak. When yields rise, this puts pressure on growth companies, so it would be encouraging for equities if yields fall, otherwise stocks may continue to struggle. A positive for the bulls is that the 10-Year Treasury yield relative strength indicator (RSI) on the weekly chart above has yet to pierce the overbought territory and remains in a bearish divergence – giving credibility to the potential double top playing out. Over the years, even when yields make new highs when also have a bearish RSI divergence, yields tend to fall over the next year, giving equities a tailwind.
Furthermore, large speculators are a smidge off record short positioning in the futures market. If this begins to unwind, we could see bonds stabilize, which would be a boon for growth stocks. Finally, while we haven’t seen junk bonds follow the bull market in equities, we haven’t seen credit spreads signal fear either when looking at the High-Yield Corporate Bond ETF/iShares 7-10 Year Treasury Bond ETF (HYG/IEF). In fact, they are breaking out of a range and a long-term downtrend, which has been bullish for stocks.
“If you are using the Cboe Market Volatility Index (VIX — 17.30) as your risk barometer, you are still holding on for a trough. Per the below graph, the VIX made another run at the 18.22 level, which is one-half the 2022 VIX peak. This half-high and the VIX’s 200-day moving average marked a peak in Friday’s trading, which might give bulls another reason to anticipate a bottom.”
– Monday Morning Outlook, August 21, 2022
While equity markets have been volatile, the Cboe Volatility Index (VIX – 15.68) has remained somewhat subdued, with many pundits proclaiming this is due to 0DTE options, and I assume if quantified, they could have some effect on the fear index. However, if there were real fear on the trading floors, the VIX would still be elevated like in 2022. Moreover, as we discussed last week, we’ve yet to clear the early 2023 lows and the one-half high of the 2022 VIX peak where it faded once again this past Monday. So, until we clear those levels, it’s hard to extrapolate that this is anything more than an orderly correction. When analyzing the VIX trend in prior pre-election years, we’ve already passed the volatility peak, and typically, we don’t see another ramp until mid-September.
Moving on, pessimistic sentiment has built up tremendously since the mid-July lows when looking at our SPX Components 10-day BTO put/call ratio below. This past week, it continued to roar higher to 0.89 and hit the most elevated reading since January 11th, 2023 — one week after the all-time high for the indicator. While this could signal that we are in or near a bottoming process, ideally, we want to witness a rollover in the ratio for confirmation as we’ve previously discussed. A positive I take away from the ratio is we’re near all-time highs while the market is nearly +15% higher since the last time we were at these levels.
This past week, we also saw active managers positioning fall once again, with the National Association of Active Investment Managers Survey Index (NAAIM) coming in at 34.36. The 2-week percentage change reading finally pushed over the -40% threshold. When this has happened in the past, it’s indicated we’re near a short-term bottom, as active managers have dialed back their bullish bets, implying the exuberant optimism has been unwound. However, there is often a lag of a few weeks, so it’s best used in conjunction with chart confirmation, as this just tells us to keep our eyes open for a turn.
The recent rout in equities has also pushed multiple breadth indicators to lows. One I closely follow for a short-term indication of overbought and oversold conditions is the S&P 500 Percent of Stocks Above the 20-day Moving Average. In mid-August, we entered what I like to call the ‘buy zone’ for equities during options expiration week. However, just because we entered the zone does not make equities an immediate buy, as I’ve highlighted previously. It tells us to be cautious of shorting into oversold market conditions and to watch for a rebound in stocks.
While it’s well known we’re in a seasonally tumultuous period, there still are opportunities afoot for nimble traders, and one could be on the horizon for the bulls as the conditions are ripe for a rally into mid-September. We maintain last week’s view that now continues to be a time to leg into some stocks around support levels while controlling risk against the recent support lows and targeting a move above the SPX 4,458 level to put on more risk.
Matthew Timpane is a Senior Market Strategist at Schaeffer’s Investment Research.
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