Key Pivot Point Could Determine S&P 500's Fate

“… 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…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…I find it amazing that total short interest on SPX components is at a level that coincides with the Covid-19 uncertainty and fear…

          - Monday Morning Outlook, September 30, 2024

The excerpt above captures various parts of last week’s commentary, giving a good representation of both the technical and sentiment backdrops to maintain a bullish outlook. This is for both the short-term and long-term.

Moreover, the comments from last week are in the context of the S&P 500 Index’s (SPX - 5,751.07) bullish inverse “head and shoulder” breakout above previous all-time highs, shortly after the Federal Reserve lowered the fed funds rate. The bullish pattern, as I have stated in prior commentaries, suggests that we could be on the cusp of a 10% rally in the coming months.          

“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.”

- Monday Morning Outlook, September 30, 2024

This projection is vague in a sense, as it doesn’t exactly explain the path or the timing of such a rally (if a rally of this magnitude even commences). In fact, as you can see on the chart below, the SPX has been dancing around the 5,725 level that I have discussed in prior weeks, as it is coincident with being exactly 20% above last year’s close.

Such round-number percentage gains often mark pauses or pivots. As of now, and thankfully for bulls, it has marked only a pause in the short term, as the SPX has not made a sustained nor marked move either above or below this level since first touched in the middle of last month. In fact, in a win for bulls, the SPX lows have held above the neckline of the bullish inverse “head and shoulder” pattern.

Record-high money market assets and short interest levels on SPX component stocks have pushed the index to an area that coincides with the likes of previous Covid-19 sentiment. It's easy to identify a potential source of fuel to drive stocks to a double-digit percentage rally in the coming months, even if the path isn’t exactly smooth nor the timing exactly clear.

As the SPX dances around the 5,725 level, the rate of ascent with respect to its 30-day moving average has slowed to about five points per day. As such, it is projected to be closer to the July peak at the end of this week. The July peak is the first level of potential support if the SPX continues to languish or trade lower in the days ahead.

The one sentiment indicator that is more in the bears' favor is the 10-day, buy (to open) put/call volume ratio on SPX components. Last week, the ratio hit a level that preceded the one-week selloff that began on the first trading day of September. During the brief but sharp selling period, the ratio quickly moved to “buy,” as pessimism swiftly became abundant.

If we see another bout of selling, I would not be surprised to see option buyers panic like they did last month, based on the caution we are seeing in other areas of the market already. For example, with the still-elevated Cboe Market Volatility Index (VIX - 19.21), the SPX component short interest, or the huge inflows into money-market assets. 

As a side note, while the VIX is elevated in the context of being well above its 2024 lows and the SPX near all-time highs - likely due to election anxiety - bulls would rather see it back below the 18.68 level, which is 50% above its 2023 close. We have experienced bouts of higher volatility and lower stock prices when the VIX is above 18.68 this year.

If it is above 18.68, it could be hinting at higher volatility. At the same time, crosses below 18.68 have been bullish. In fact, a push below 18.68 might signal the timing of a strong upcoming rally.

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

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