Although the SPX held up, there were sectors that were not immune to 10% corrections
The first half of 2021 is behind us and with it a lot of excitement, depending on where your investment or trade focus is. There was the boom / bust / boom in meme stocks. Bitcoin (BTC), last year’s superstar, was another hot topic, crashing 50% from April to May. Everyone who bought and held this cryptocurrency in late January and held it until Friday is now under water.
If you are in tune with the financial media, you will know the deep decline in commodities right at the time the inflation debate got underway. Whether gold, lumber, wheat, zinc or copper, corrections on the commodity market are in abundance. Bonds got rolling, with the iShares 20+ Year Treasury Bond ETF (TLT – 145.04) down 15% in the first three months of 2021. Stock volatility, an asset class that we are closely following as measured by the Cboe Market Volatility Index (VIX – 7/15), also crashed. From its peak in January to early April, this measure fell by more than 50%.
At the same time as equity volatility plummeted, the “boring” S&P 500 Index (SPX – 4,352.34) made a new high after a new high at the end of the first half of 2021. While the index has seen some setbacks, these have been extremely mild compared to most other assets.
While the SPX held up, there were sectors that were not immune to 10% corrections, which put investor nerves to the test. For example, exchange-traded funds like the tech-heavy Invesco QQQ Trust Series (QQQ – 358.64) and the Financial Select Sector SPDR Fund (XLF – 36.94), in addition to the Invesco Solar ETF (TAN – 88.18), all saw corrective movements in the first half of 2021. If you If you like exchange-traded funds with an international focus, you were not spared the 10% corrections in the iShares MSCI Emerging Markets ETF (EEM – 54.78).
In other words, when you are on record that “a fix is coming,” bow your bow if you are not referring directly to the SPX. We have been inundated with corrections and crashes in popular assets – cryptocurrencies, numerous commodities, bonds, volatility, and subsectors of the broader market.
With many assets struggling at some point in the first half of 2021, the SPX rebounded in an orderly fashion. Many of you are now familiar with a chart I post weekly that shows a channel that has been trading the SPX since mid-November or above, when promising headlines about vaccines for Covid-19 first surfaced. In fact, there were only 11 or 12 closes below this upward sloping channel for the first six months.
After a sell-off in June expiration week pushed the SPX to the bottom of this channel, the SPX not only made up for those losses, but also made an excellent start into the second half of 2021. In fact, the top of this channel is very much at play as a potential resistance area between 4,375 and 4,390 to start a shortened Independence Day week.
On April 9th, the SPX broke above the possible resistance from the upper bound of this channel. At that time, option buyers made a multi-month high in the bear market in the SPX components, as shown by the late March high of the 10-day buy-to-open put / call volume ratio of the SPX component.
After the breakout, these short-term traders turned increasingly bearish and the SPX continued to slide across the channel through early May. The SPX eventually slumped back below the channel when options speculators suddenly turned bullish.
This time as the upside of the SPX channel comes back into play, option buyers on SPX components are still pumping bearish bets in late May, but the ratio is much lower than in early April. The extremely low in this ratio reduces the likelihood of enough firepower available to push the SPX through the upper limit of its channel – at least for an extended period of time.
In fact, while the direction of the rate is bullish, the absolute level of that rate – which is below the 2021 low at the end of January – increases the risk of a short-term pullback. For example, in late January, the SPX began to decline to the lower bound of this channel after studying the upper bound of the channel for a few days (see circle in the graph above).
If the pullback repeats in late January, a natural level of support is the mid-June closing high at 4,255, which preceded the expiration week sell-off. This level coincided with the lower bound of the channel at Friday close of trading.
The momentum in the market and successive highs suggest that the bullish course should be maintained. But sentiment indicators suggest that the risks of a pullback are increasing. If hedging is not your preferred risk management method, another strategy to consider is long stocks in stocks. But by taking advantage of the leverage options on offer, you are still able to make significant dollar gains if the momentum continues to move higher like April and May.