Last week pullback signs began to appear as the S&P 500 Index declined every day gaining downside momentum as the week ended. Slowing GDP growth, resurging Covid case counts along with supply shortages filled the headlines and began to change sentiment. In addition, September seasonal weakness could be making some 'buy-the dippers" hesitate. The Market Review explains along with a WTI Crude Oil update.

S&P 500 Index (SPX) 4458.58 slipped 76.85 points or -1.69% last week with the largest and most noteworthy decline occurring on Friday. For three of the four trading days risk-off sectors held up better than the more cyclical risk-on sectors. Both the 50-day Moving Average at 4424.26 and the operational upward sloping trendline are likely to provide support on any further pullback this week.

Monday it likely opens lower and tests the 50-day Moving Average. Will it hold and attempt to reverse or continue lower? It's the continue lower alternative that needs hedging. If it then turns up in the next few days consider it like the cost of insurance. Odds are the 50-day Moving Average holds since it contained the last 9 pullbacks after the October 30 double bottom low with two exceptions on March 4 & 5 when it briefly traded below the 50-day before quickly turning up again.

Imagine going to the track on a sunny Saturday afternoon. If the favorite thoroughbred won its last 9 races, would you bet it to lose the next? Perhaps, if you suspected a recent injury. Even then, your bet would probably be small.

Invesco QQQ Trust (QQQ) 376.59 declined 4.98 points or -1.31% last week with more than half of the decline occurring Friday although for the week it declined less than the SPX (-1.31% vs. - 1.69% ) with the big cap tech stocks holding up better than the broad market as narrowing market breadth shown below confirms. Support at the 50-day Moving Average of 367.86 and the slightly higher upward sloping trendline will likely be challenged early in the week and the odds favor the support will hold. However, should it continue lower and close below the 50-Day Moving average consider reducing or begin hedging long positions.

CBOE Volatility Index (VIX) increased 4.54 points or +27.67% last week to end Friday at 20.95. Our similar IVolatility Implied Volatility Index Mean, IVXM using four at-the-money options for each expiration period along with our proprietary technique that includes the delta and vega of each option, added 4.19 points or + 39.12% to end at 14.90% compared to 10.71% for the week ending September 3.

Our estimate of the mean for the current relevant range begins on June 5, 2020, at 19.70% and slopes downward, ending Friday at 15.57%. Our estimate of the mean for the current relevant range that begins on June 5, 2020, at 19.70% and slopes downward, ended Friday at 15.16%, just above Friday's close.

VIX Futures Premium

VIX futures premium on Friday closed at 1.38%, in the yellow caution zone between zero and 10%.

The rapidly declining time value of the front-month September futures that expire Wednesday contribute to the low premium with October futures not much better at 1.46%.

Since most of the volume and open interest are in the two closest futures contracts measuring the volume-weighted premium relative to the standard 30-day VIX provides a good real-time sentiment indicator based upon actual commitments of large Asset Managers and Leveraged Funds. The chart reflects the distance from the VIX to the futures curve computed from the two front-month contracts.

VIX-VXST Spread

While the VIX Index is calculated using monthly options with 30-days to expiration, VXST uses options with 9-days to expiration and include options that expire in one week making then more sensitive to changes in short-term implied volatility. This spread measures the distance from the 30-day VIX to the 9-day VIX to produce an indicator.

Last week Digest Issue 36 "Better Breadth [Charts]" made the bull case with the spread at +4.75, for the week ending September 3. As of Friday, the picture changed dramatically, like comparing sweet to sour as short-term implied volatility increased faster than the standard 30-day measure. Friday the spread ended -1.63 giving another caution signal. However, notice down spikes below zero typically recover quickly.

Market Breadth as measured by our preferred gauge, the NYSE ratio adjusted Summation Index that considers the number of issues traded, and reported by McClellan Financial Publications. Last week confirmed more risk-off rotation activity into big cap liquid stocks as the index declined 50.13 points or -38% to end at 81.79, disappointing the bulls.

Breadth divergences will be resolved either by the major indices declining or greater participation by more issues. Last week more issues declined than advanced.

WTI Crude Oil (CL) 69.72 basis October futures ended the week .43 points or + .62% higher. Cash ended Tuesday, September 7 at 68.35 down .16 for the week.

The most recent top occurred on July 13 at 75.25 just .05 above the previous top made on October 2, 2018, at 75.20. See the two tops in the chart above. 

According to the CFTC's Disaggregated Commitments of Traders - Options and Futures Combined report, COT as of Tuesday, September 7 "Managed Money" including commodity trading advisors (CTAs), commodity pool operators (CPOs), such as commodity ETF managers and “hedge funds” continued reducing their longs, shown as a percent of the total open interest.

Then began increasing their shorts.

Since one hand can't clap, Producers, Merchants and Processors (PMP) take the other side of the trades. This chart shows the net position (longs -minus shorts) as a percent of the total open interest.

From a net short position as high as 6.02% on June 23, 2020 to net short around 2% from September 22, 2020 to August 10, 2021 when they turned net positive moving from negative 3.01% (as in hedging production ) to +1.50% representing 40,870 net long contracts.

Another important indicator compares total open interest to price since open interest needs to keep expanding to sustain price trends both up and down. This Z score chart shows the current relationship. When it starts declining the current trend either up or down begins to run out of gas.

Notice on the left, open interest peaked on May 15, 2018, two months before prices started declining in the summer of 2018.

Now at 2.72 million contracts as of September 7, it peaked at 3.21 million on June 15, a month before the recent top made on July 13 at 72.25 basis cash.

Although reports of production shortages due to hurricane Ida and Natural Gas prices above $5/MMBtu likely explain the current positioning of the Producers, Merchants and Processors, the price trend appears vulnerable based upon "Managed Money"  positioning and declining open interest.

Strategy

In bull markets, a good strategy is to stay long equities and/or ETFs and then tactically hedge pullbacks as they begin developing, since ordinary pullbacks can become corrections when something unexpected happens. Then corrections can become downturns when something else unexpected happens, and downturns can become bear markets when many unexpected things change medium and long-term fundamentals.

After a much weaker jobs report on Friday September 3, followed by the Federal Reserve’s latest Beige Book saying a “deceleration” in economic activity in August, especially in dining out, travel and tourism, was linked to the spread of Covid Delta, with events canceled throughout the U.S. the equity markets began seeing storm clouds gathering.

The combination of  seasonal weakness in September along with some early signs of economic slowing as both the SPX and QQQ will likely test support at their respective  50-day Moving Averages consider hedging individual long positions with option collars if support fails to hold. Should it become necessary hedge the broad market with SPY put spreads or the ProShares UltraPro Short QQQ (SQQQ) described in Digest Issue 34 "Breadth Disappoints [Charts]." 

Summary

Last week the indicators turned negative as the S&P 500 Index declined every day and now challenge the important support from the 50-day Moving Average. Although odds favor support holding, changing economic fundamentals could turn a modest pullback into something more severe. On multiple closes below the 50-day Moving Average, begin reducing long positions and initiate hedging strategies.