I n last week’s note I compared the similarities between the Volatility (VIX) futures in 2012, 2016 with today highlighting that a drop below support at 26-27 on the March VIX futures would be a bullish signal for the S&P 500. I would encourage investors and traders to continue to monitor the VIX futures particularly as markets transition into the upcoming earnings season and increasingly contentious election. At the risk of stating the obvious, no one knows how markets will react, but as usual, I expect the technical backdrop to be one of the more useful tools to gauge risk reward heading into the election.
First, let’s discuss the backdrop heading into October. The equity market surge through Q2-Q3 pushed most weekly technical indicators, tracking 1-2 quarter swings into overbought territory by mid Q3. A correction into the seasonally weak late Q3 period is underway which we continue to view as a healthy, albeit unpleasant, technical development necessary to unwind the overbought condition.
For reference, a similar technical backdrop was in place heading into Q4 2012 and Q4 2016. Stock markets had rebounded strongly from cycle lows in Q4 2011 and in Q1 2016 and corrections developed from overbought levels that developed in late August into the election each of those years. If history is a guide, it would not be surprising to expect further weakness into the election with support around the rising 200-day moving average, currently 4-5% lower. Of course, volatility is more extreme this year so an overshoot to the downside remains a risk. The S&P is already down 10% whereas the correction in the Fall of 2012 was -8.6% of which -2.5% was a temporary undercut below the 200-day moving average. In the Fall of 2016, the correction was -5% with the S&P 500 rebounding from almost to the point from its rising 200-day moving average.
I see three main trading levels to be aware of in the coming weeks. The first is where the S&P bounced from this week near the June highs at 3233 coinciding with its rising 100-day moving average marked in yellow on this this week’s chart. Interestingly in both September 2012 and September 2016, the S&P bounced from near its 100-day moving average for a short 1-2 week bounce before heading lower into October. I expect a similar temporary bounce to develop from current levels and view the declining 50-day moving average near 3350 as a likely level for the S&P to stall at heading into month end mid next week. The next two levels that are important technically are at the 200-day moving average at 3115 (-4.5%) followed by the late June lows near 3000 (-8.5%).
Bottom line: My expectation is that a temporary bounce is likely developing but the market likely needs more time to digest the overbought condition that developed into August and the uncertainty heading into the election. My bias is that the next buying opportunity is likely to develop between next month’s option expiration (10/21-10/23) and the end of October. As a reminder, keep a close eye on the VIX futures heading into that time period.
Figure: Weekly Sector Review
Source: FSInsight, FactSet
Figure: Best and worst performance sectors over past 3 months
