To those willing to tune in during the past month, the market’s technicals have been telecasting the next move in the S&P 500 and other major indices, which are wrangling with a few key trendlines.
Since topping out in May, the S&P 500 has declined 5% to its lows, then bounced within a relatively tight range after the decline. Now, the merging of two telltale trendlines holds the determination of the next 5% to 10% move in stocks.
First, the overhead 20-day moving average of the SPX, currently residing at the 1638 price level. Since closing below this well-watched short-term trendline on May 31, the SPX has only been able to conjure up a single close above it. The failure of the SPX to move above this trendline should provide a familiar warning for chart-watchers, especially when combined with the 50-day activity.
Since the summer swoon started, the S&P has been able to build up strength each time it has approached the 50-day MA. On two occasions (identified by the green arrows in the chart below), the SPX 50-day has been able to act as support, giving the market some confidence that the current pullback would contain itself to a shallow 5%.
This week, things have changed as these two important trendlines have engaged upon a crash course.
The technical squeeze play will be a big factor in determining the SPX’s next move, but Wednesday’s post-Fed action shifted the balance of power to the technical bears.
In muddying the tapering water further, Ben Bernanke’s post-FOMC comments yesterday caused a spike in Treasury yields along with a significant drop in stocks, bringing the S&P 500 to a critical testing point. Today’s action is testing two critical support levels — the index’s 50-day MA and the psychologically significant 1,600 level.
Traders will take their cue from the S&P 500’s response, and it’s as simple as this:
- A close above these levels by Friday afternoon will signal that the technical buyers are stepping in, despite the interest-rate situation. We then expect the market to easily take out the overhead 20-day and progress toward the 1,680 mark in short order.
- A close below the 1,600 level will trigger a round of selling pressure that has been building up in the market for more than a month. The selling would shoot the SPX to its first round of support at 1,580, but likely not stop until it hit the next psychologically important level of 1,550.
As always, we like to identify a few ways to profit from the expected move in the market.
ProShares UltraShort S&P500
Click to Enlarge The ProShares UltraShort S&P500 (SDS) exchange-traded fund allows investors to go short the market, offering an inverse, leveraged return to the S&P 500.
Or, in plain English: SDS is designed to go up roughly 2% for every 1% drop in the SPX. (But remember that between expenses — in SDS’ case, 0.89% — and the tendency of leveraged funds to wiggle a lot over time, you’ll rarely see an exact 2-for-1 movement.)
For now, we’re expecting the SPX’s pullback to produce another 3%-5% decline, meaning you theoretically could grab 10% or more on a short-term portfolio hedge.
iPath S&P 500 VIX ST Futures ETN
Click to Enlarge We always like to trade market volatility like the professionals by using the iPath S&P 500 VIX ST Futures ETN (VXX).
VXX units serve as a proxy for movements in the CBOE Volatility Index — more commonly known as the VIX, or “Fear Index” — meaning they should climb higher along with the VIX.
For now, we’re targeting a move back above $20, perhaps near $22, on the VIX, which represents a 20% spike in volatility. The VXX doesn’t move penny-for-penny with the VIX, but the shares will offer a nice hedge against short-term volatility.
ProShares UltraShort 20+ Year Treasury
Click to Enlarge The ProShares UltraShort 20+ Year Treasury (TBT) fund hedges declines in the long-term Treasury market, meaning these units should appreciate as yields move higher.
The jump in the 10-year yield suggests that the rush to the door might be taking place in the bond market as investors try to avoid the drop in values that accompanies rising rates. We don’t see the 10-year backing off of its ascent, suggesting the TBT could be set to make a run to $80 over the summer.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.