“…the SPX’s move above the July, August, and pre-FOMC rate-cut highs completes a bullish inverse ‘head and shoulder’ breakout…the bullish pattern suggests that we could be on the cusp of a near 10% rally in the coming months.”
-Monday Morning Outlook, September 23, 2024
In last week’s commentary, and on the heels of the S&P 500 Index (SPX -- 5,738.17) carving out a new all-time high, I discussed the potential implications of a bullish pattern that could be indicative of a double-digit rally in stocks in the coming months.
For many, including myself, this may be hard to fathom in the context of the SPX’s more than 600-point, 12.5% rally from its early August low. However, the index moved higher since its Sept. 19 breakout above the neckline of the inverse “head and shoulder” pattern that triggered the bullish signal. The upward price action occurred during the historically weak month of September.
What’s more, the SPX pushed above 5,724 after marking its Sept. 19 high. This level is exactly 20% above last year’s close, and has been touched a few times, including the lows during Thursday’s and Friday’s sessions. Long-time readers know about the tendency of pauses and/or pivots around such round year-to-date percentage gain or loss levels. A recent example is the March-April highs that were around 10% above the SPX’s 2023 close and preceded a notable short-term pullback.
Profit-taking has not yet been evident, with the SPX roughly 20% above last year’s close, but there hasn’t been a lot of urgency among buyers either.
So, even after the huge gains in stocks in a short period, is there anything that could power the SPX to a double-digit gain in the next few months, as the bullish inverse “head and shoulder” pattern breakout suggest? Or are potential buyers exhausted?
From a contrarian perspective, the latter question needs to be answered, as there must be evidence that there is buying power left.
The excerpts below give me a sense that yes, there is evidence of caution, and thus sideline money that could further fuel the momentum. There is also quantified evidence that supports the case of future buying power.
“The runway is clear for the stock market to keep powering higher once the US presidential election is decided, says Goldman Sachs Group Inc.'s David Kostin. The firm’s chief US equity strategist expects the S&P 500 Index to trade around the 6,000 level a year from now, he said Tuesday in an interview with Bloomberg Television. The forecast implies a roughly 5% gain from Monday’s record close…investors will probably have to navigate some market turbulence in the weeks ahead as the election between Vice President Kamala Harris and former President Donald Trump looks set to come down to the wire. Historically speaking, it’s a period when volatility tends to rise and equities prices decline”
“Americans’ dash for cash isn’t over yet. Investors have poured $126 billion into money-market funds since the Federal Reserve’s jumbo-size interest-rate cut… assets in such funds to a record $6.76 trillion as of Tuesday, based on Crane Data going back to 1998…The trillions of dollars sitting in cash have been a fixation for big Wall Street investors and market watchers alike. They have been trying to divine what the sum will mean for the path of stocks, which have historically provided the highest returns in the long run.”
-The Wall Street Journal, September 26, 2024
The excerpts above are, in my opinion, related and potentially bullish in their implications. A major brokerage house strategist, while bullish, only sees the SPX gaining roughly 5% well into 2025. If this sentiment represents the outlook of many would-be equity investors, it might explain why so much cash has been poured into money-market funds, whose yields may compete with the outlook for stock returns in the next year.
After the recent breakout above former highs, continued stock momentum may cause money-market investors to deploy money-market assets into stocks, for no other reason than fear of missing out.
The evidence of caution is in the short-term outlook too, where election uncertainty may be keeping people on the sidelines, or even betting against stocks. Not only is it evident in this strategist’s comments, but note that the CBOE Market Volatility Index (VIX -- 17.18) is more than 30% above last year’s close and well above this year’s lows (which are in the vicinity of last year’s close).
I find this intriguing, with the SPX up more than 20% this year and recently breaking out above former highs. You might anticipate that volatility expectations, as measured by the VIX, would be around this year’s lows. But if those selling portfolio insurance are perceiving strong demand due to election uncertainty -- or whatever else may be lurking -- this will elevate option prices and, therefore, the VIX.
The second graph below might surprise you. Short interest data as of mid-September was released early last week, with the first half of September showing the SPX nearly flat amid increased volatility. The shorts smelled blood during the bout of volatility, and SPX component short interest rose nearly 2% to its highest level since the March 2020, Covid-19 high.
I find it amazing that total short interest on SPX components is at a level that coincides with the Covid-19 uncertainty and fear. The take-away is that short covering could be a source of fuel for sharp gains in the next few months.
Risk-reward favors the bulls. But the SPX is overbought by some measures as it flirts with a level (20% above last year’s close) that could spell pause action or a pivot.
If sellers prevail in the short term, I see two levels of potential support. The first is the 5,650-5,665 area that marked resistance since July. Another is the upward sloping 30-day moving average, which has acted as support and resistance multiple times during the past year. This moving average comes into the week at 5,610 and is rising about 11 points per day, which means it could be sitting at the July high this Friday.
Todd Salamone is the V.P. of Research at Schaeffer's Investment Research.
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