Another Pullback is Approaching

The stock market is caught between a rock and a hard place as the summer heat is providing no solace for a resurgence in covid cases that are likely to threaten the return to economic normalcy.  Second quarter EPS may not be a complete disaster due to temporary re-openings, but future quarters may need to be discounted under renewed threat of viral infections.  Talks of the next stimulus package now indicate some reluctance to continue the largess seen in the past as the additional $600 bonus over unemployment checks maybe limited.  Current election polls are also showing the Dems as a clear favorite with Biden's new plan to include higher corporate taxes and limits on stock buybacks, the pillars of the "Trump rally".  However, we still have the Fed.

Sentiment still seems to be following the script from July-Oct 2018 with the recent June swoon matching July 2018 with several months expected before an INT top.  Everyone is expecting a "C" or crash wave to follow the next INT top, but alternation could result in a more complex correction.  Both Jan 2018 and Feb 2020 tops were followed by crashes, but Oct 2018 saw a multi-month correction lasting thru Dec.  The next time may be more like the latter, with an initial decline in the Fall and a second wave after the election if the Dems win.

Shorter term, the question is whether the next stimulus round is a "buy the rumor, sell the news" reaction or the reverse for the stock market.  Current price action is indicating the former with the next potential top around the SPX 3250 over the next week to 10 days.  The following pullback as evidenced by current sentiment is likely to be only half that of June as seen in Aug 2018 or to about 3100-50.


I. Sentiment Indicators

The overall Indicator Scoreboard (INT term, outlook two to four months) bearish sentiment is again falling, hovering around the levels seen during the Aug-Sept 2018 period.  Both this and the ST indicator failed to spike strongly above neutral during the June pullback and may mean a failure to reach an ATH.

The INT view of the Short Term Indicator (VXX $ volume and Smart Beta P/C [ETF Puts/Equity Calls], outlook two to four months) bearish sentiment has remained at levels last seen between Nov 2019 to Feb 2020 that may be pointing to a large increase in volatility once an INT top is reached.

Bonds (TNX).  Interest rates and bond sentiment remain at record lows.

For the INT outlook with LT still negative, the gold miners (HUI) bearish sentiment remains very low and will probably see prices inversely follow int rates (TNX).

II. Dumb Money/Smart Money Indicators

The option-based Dumb Money/Smart Money Indicator as short/INT term (outlook 2 to 4 mns/weeks) bearish sentiment remains similar to late 2019-early 2020.

And the sister options Hedge Ratio sentiment remains somewhat higher than other sentiment measures, probably indicating "cautious bullishness" as hedges are maintained against bullish positions and may provide some support for the markets ST.

III. Options Open Interest

Using Thur closing OI, remember that further out time frames are more likely to change over time, and that closing prices are more likely to be effected. Delta hedging may occur as negative reinforcement when put support is broken or call resistance is exceeded.  This week I will look out thru July 17. Also, this week includes a look at the GDX for July exp.

With Fri close at SPX 3185, options OI for Mon shows small support at SPX 3150 and strong resistance at 3200.  Futures show further gains after hours, but a move over 3200 seems unlikely.

Wed has modest OI where SPX shows modest support at 3180 and only small call resistance up to 3300.  The large straddle at 3150 may tend to pull prices lower.

For Fri PMs, moderate OI shows stronger call resistance over SPX 3150, but stronger put support below 3150.  The most reasonable outcome is a close near 3150 to cause "max pain" or loss of option premium.

Using the GDX as a gold miner proxy closing at 38.4, the GDX is completely ignoring all call resistance and over 38, the next resistance is at 40. 

Currently the TLT is 166.3 with the TNX at 0.63%. 

IV. Technical / Other

First, a look at the NYSE Adv/Dec Line shows a weakening trend in advancing issues that has spelled trouble each time it has occurred in 2020 and indicates the potential for a retest of the recent lows (SPX 2950-3000).

Recently the Equity P/C to SKEW spread has again been testing the lows last seen right before the SPX June swoon of 8% which seems to be following the pattern of July-Oct 2018.

However, using the absolute measure of Equity P/C to equity calls (higher calls = more speculation) as a ST indicator, we see that speculation is weaker and currently implies a smaller pullback.

Likewise for the ST Equity P/C to ETF calls that is barely below neutral.

Conclusions.  Several weeks ago, I indicated that the next round of stimulus, expected to be a $1T+ Cares package, would likely raise the SPX to test the June highs at 3250.  Now with projections of $1.5T due late July to early Aug, the question remains as to whether the pullback will precede or follow a test of SPX 3250.  Recent price action is stronger than expected, implying a "buy the rumor, sell the news" event but options OI is still suggesting a less direct route forward.

Current sentiment supports a 3-5% pullback from current levels, but a continued advance may result in more extreme sentiment followed by a larger pullback.  One such scenario is suggested by Trader Joe where an EW WXY pattern reaches SPX 3250 then pulls back to 3000.

Weekly Trade Alert.  No clear path at this time.  Updates @mrktsignals.

Investment Diary,  Indicator Primer,
 update 2020.02.07 Data Mining Indicators,
 update 2019.04.27 Stock Buybacks,
 update 2018.03.28 Dumb Money/Smart Money Indicators

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