“From a short-term perspective, the SPX enters standard July expiration week in an oversold condition, according to its 14-day Relative Strength Index (RSI). Bears should be aware that this has been the case on most days since mid-June.., implying the index is trending… This does not mean we aren’t vulnerable to a pullback as anything is possible, but in most instances this year oversold conditions have been resolved via sideways movement.”
-Monday Morning Outlook, July 15, 2024
July standard expiration week finally saw the S&P 500 Index (SPX--5,505.00) give in to its overbought condition that had persisted for the first half of July and multiple times since mid-June. But another new-all time high was carved out first before sellers dominated the action on Wednesday through Friday.
The 2% pullback pushed the SPX’s 14-day Relative Strength Index (RSI) to its lowest reading since early May, which proved to be an opportune time to buy stocks following a pullback and sideways action in April, a month that proved up to this point to be the worst for stock market bulls in 2024.
One interesting aspect of last week’s expiration week action is how the SPDR S&P 500 ETF Trust (SPY--548.99) failed to sustain a move above the “call wall” at the 562 strike on 7/19 expiration options, and Friday’s closing bell rang before the 545 strike came into play. This is a strike where put open interest was huge relative to call open interest, and could have fueled delta-hedge related selling if broken to the downside.
The Wednesday morning gap back below the 560 and 562 call strikes likely spurred the unwind of long positions associated to call open interest at those strikes, generating steady selling into the end of the week.
Small-cap stocks, as measured by the Russell 2000 Index (RUT--2,184.35) participated in the mid to late-week selling after making a multi-year high last Tuesday. Its overbought condition lasted only a day or so, and was the first time this index had moved into official “overbought” territory (14-day RSI reading above 70) this year.
The decline last week occurred as option buyers on SPX component stocks are at their most enthusiastic since this time last year, as measured by the 10-day, buy (to open) put/call ratio.
Per the chart below, the current reading of this ratio is at the level that preceded a three-month SPX decline from late-July through late-October last year. At the same time, it is around levels that since July 2023 have marked other troughs in the ratio, but not tops in the market. Nonetheless, this is something to keep on your radar as a risk to the short-term bull case if the technical backdrop deteriorates in the days ahead.
A difference between July 2023 and the present is whereas short covering partly drove stocks into the July 2023 high, this year’s market has been accompanied by shorts building positions. As such, total short interest now is almost 20% higher on SPX components relative to last year, which means the potential for short covering support is higher now than last year.
“I am continuing to monitor the SPX’s 30-day moving average, which has acted as support on two of the three pullbacks this year. This moving average comes into the week at 5,450 and, based on its slope, projects to be around the 5,500-centruy mark at the end of the week, which is coincidentally the area that is 20% above the July 2023 closing high that preceded the correction into late October…”
-Monday Morning Outlook, July 15, 2024
The SPX enters this week at a critical juncture relative to its 30-day moving average that I have been discussing throughout the year. It has marked support (January and May 2024) on two pullbacks this year and was resistance in October 2023.
Crosses below this moving average (August and September 2023, April 2024) and crosses above (November 2023 and May 2024) have also been reliable sell and buy signals for almost a year, with the exception being a false buy signal in August/September 2023.
As such, with the SPX at the round 5,500 half-millennium level that coincides with the area of its 30-day moving average, the SPX will have to “right itself” quickly in the week ahead.
A cross below this moving average could signal short-term selling like we saw in April, when the SPX eventually troughed at its 100-day moving average, which is currently situated at 5,272 and in the vicinity of the March highs, or about 4% below Friday’s close.
Also, any additional weakness could spur profit-taking as the SPX comes into the week 20% above its level last year and marks the December breakout level above the July 2023 peak. Those that bought the breakout may reduce risk if the profit from the breakout trade falls below 20%.
If the SPX falls below its 30-day moving average, equities are at increasing risk of additional selling over the next month and perhaps into the election.
Todd Salamone is the V.P. of Research at Schaeffer's Investment Research.
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