After Massive Rally Off March Lows And Options Waiving Caution Flag, Johnny-Come-Latelies Risk Holding The Bag

Overbought on the daily timeframe, major US equity indices are right at, or near, the upper bound of the recent trading range. Volume has dried up, and bulls are staying put, hoping for a breakout. Should one come about, there is potential for short squeeze and for sentiment to get frothier. After that, risk-reward odds decidedly favor bears.

Off the March lows, major US equity indices have had phenomenal rallies.Action is top-heavy, with large-cap generals well ahead of their smaller-cap soldiers. Both the S&P 500 large cap index (SPX) and the Nasdaq 100 index (NDX) have retraced more than 61.8 percent (golden ratio in Fibonacci lingo) of their February-March decline, while the Russell 2000 small cap index retraced 50 percent of its. 

Amidst this feel-good story, volume has dried up, and indices have entered a sideways pattern. At best, they are consolidating their gains, for another leg higher. At worst, they are simply tired.

On the S&P 500, the index tagged 2954.86 on April 29. Last week, it closed at 2955.45. In between, it made a low of 2766.64 on May 14, and a high of 2980.29 last Wednesday. That low, at the daily lower Bollinger band, was bought, while the high, at the upper band, was sold. Although the fact remains that the index remains at the upper bound of the recent range (Chart 1). Plus, the 200-day moving average lies right above at 2999.72, not to mention the psychologically important round number 3000. 

Bulls obviously are hoping for a breakout and staying put. Should one occur, there are some potential tailwinds.

The S&P 500 bottomed on March 23. From the week ended March 25, through last Wednesday, $38.2 billion left US-based equity funds, including last week’s $4.9 billion (courtesy of Lipper). Similarly, from March 23 to May 20, SPY (SPDR S&P 500 ETF), VOO (Vanguard S&P 500 ETF) and IVV (iShares Core S&P 500 ETF) collectively lost $13.3 billion, including $4.6 billion in the week through last Wednesday. In other words, the rally is being used as an opportunity to lighten up. 

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