'Sell In May' Will Determine The Fate Of The Bear Market Rally In S&P 500
Summary
- S&P 500 erased 4%+ intra-week gains to close negative as selling intensified heading into May.
- Bearish shooting star candlestick pattern in SPX points to more near-term downside with 50-day moving average most likely to be retested.
- CBOE Volatility Index (VIX) bounced off 20-week moving average just above 30 and looks set to resume higher.
- A close below 50-day moving average in SPX would decisively end the 30%+ massive bear market rally.
Following a devastating Q1, U.S. stock markets came back to life in April, as S&P 500 (SP500) overcame record drops in major economic indicators such as consumer spending, services ISM, etc. to post the best monthly gain (+12%) since 1987. Though if we dissect further, bulk of the explosive gains were made during the first 10 trading days of the month, with S&P 500 largely unchanged over the past 2 weeks after higher highs were rejected ahead of the 50-week moving average:
Shooting Star Candlestick Pattern in S&P 500 Weekly Chart
Source: Investing.com
In the process, an ominous "shooting star" reversal candlestick pattern was formed last week after a 2-day decline wiped out more than 4% of intra-week gains. Such technical pattern warrants our attention, as we noticed that similar "shooting stars" had marked the end of previous bear market rallies between 2001-2002:
Shooting Star Candlestick Patterns During 2001-2002 Bear Market
Source: Investing.com
To remove the subjectivity that tends to come with technical analysis, we will use a mathematical approach and attempt to quantify the significance of such candlestick pattern. Specifically, below we identify all similar occurrences in the SPX over the past 100 years based on the following criteria:
- SPX advanced at least 1% higher intra-week from last week's close
- but closed negative on the week near the lows
- SPX was in the midst of a rally over the past 4 weeks
- while trading under its 50-week moving average
Weekly Shooting Star Candlestick During A Bear Market Rally Since 1930
| Date | SPX | This Week's High - Last Week's Close | This Week's Close - Low | 1-Week Chg | 4-Week Chg | vs. 50-Week MA | SPX Forward Chg | 2-Week | 4-Week | 12-Week |
| 1930-07-28 | 21.11 | 1.49% | -0.14% | -1.81% | 4.25% | -12.51% | -1.94% | 1.23% | -15.96% | |
| 1931-03-09 | 17.32 | 2.54% | 0.00% | 0.00% | 0.81% | -11.78% | -0.64% | -4.97% | -22.63% | |
| 1938-05-09 | 10.26 | 1.92% | 0.00% | -1.63% | 0.59% | -18.72% | -9.55% | -4.48% | 23.39% | |
| 1939-05-08 | 11.21 | 1.96% | 0.00% | 0.00% | 5.46% | -7.26% | 2.50% | 5.26% | 6.16% | |
| 1940-09-23 | 10.58 | 2.93% | 0.00% | -0.09% | 0.76% | -7.35% | 0.00% | 1.42% | -1.61% | |
| 1942-01-05 | 8.85 | 2.25% | 0.00% | -0.45% | 1.37% | -8.83% | -0.11% | 0.00% | -8.36% | |
| 1942-06-08 | 8.32 | 1.19% | 0.00% | -0.60% | 5.58% | -8.13% | -1.08% | 5.77% | 3.49% | |
| 1947-01-06 | 15.24 | 1.18% | 0.00% | -0.13% | 0.46% | -10.24% | -0.20% | 5.77% | -0.39% | |
| 1984-04-30 | 159 | 1.39% | -0.11% | -0.49% | 2.33% | -2.67% | -2.09% | -3.69% | -4.98% | |
| 1988-01-04 | 243 | 5.95% | -0.18% | -1.49% | 3.43% | -15.43% | 1.27% | 3.11% | 6.36% | |
| 2001-01-29 | 1349 | 2.10% | -0.06% | -0.40% | 3.94% | -4.78% | -3.55% | -8.54% | -7.15% | |
| 2001-05-21 | 1277 | 1.86% | -0.12% | -1.09% | 1.98% | -5.44% | -1.01% | -4.11% | -9.07% | |
| 2002-11-04 | 894 | 2.74% | -0.35% | -0.69% | 7.11% | -12.54% | 4.00% | 1.95% | -4.36% | |
| 2020-04-27 | 2830 | 4.16% | -0.32% | -0.21% | 13.74% | -5.41% | ||||
| Average | -0.95% | -0.10% | -2.70% | |||||||
| Median | -0.64% | 1.23% | -4.36% | |||||||
| % Positive | 23.08% | 53.85% | 30.77% |
In brief, there is a roughly 80% chance of a sell-off following the formation of the shooting star pattern during a countertrend rally (SPX positive in last 4 weeks) in a long-term downtrend (SPX trading under 50WMA). One notable exception is the post-1987 October market crash, as SPX nullified the bearish pattern and went on to march towards new all-time highs after closing the 50WMA.
Source: Investing.com
SPX In No-Man's Land Between 50-Day & 200-Day Moving Average
As the above analysis illustrated, the 50-week moving average had historically been the line in the sand between continuation of a bear market or the start of a new bull market. Likewise on a daily basis, the 50 and 200-day moving average have an equal importance in terms of determining the fate of a bear market rally. Currently, the SPX resides right between the two key moving averages after the impressive 30%+ launch off the lows:
Source: WingCapital Investments
As discussed in the previous article, until SPX finally leaps over the 200-day moving average, this remains no more than a snapback rally, which is on the verge of rolling over after last week's shooting star reversal pattern. During the Great Depression, occurrences of the reversal pattern portended at least a retest of the lows:
Source: WingCapital Investments
In the most bullish scenario, namely after the October 1987 crash, S&P 500 was repelled multiple times under the 200DMA before finally breaking through while forming a golden cross at the same time (50DMA crossing back above 200DMA).
Source: WingCapital Investments
Hence, whether the current bear market rally can actually turn into a bull market hinges on the SPX closing back above 200DMA (~3000) on a sustainable basis. On the other hand, should the SPX collapse back under 50DMA (~2750), the bear market will most certainly resume course resembling the 1930s and 2001-2002 trajectories. Until either scenario happens, the whipsaws between the two lines ought to be viewed as noise in our opinion.
Mean Reversion in VIX May Have Run Its Course
As fear continues to wane in light of the corona-curve flattening and the Fed restoring order with infinite QE, the VIX (VXX) dipped under the 40 handle while slipping below the front-month futures (VX1) for the first time since the crisis started:
Source: WingCapital Investments
While the term structure turning back to contango can be interpreted as a sign of stability in the market, it would be premature in our opinion to suggest the bear market is over given the fact that the VIX has continued to stay above the 20-week moving average for the 11th week in a row:
Source: WingCapital Investments
Looking back, when the VIX's term structure turned contango while trading above the 20-week moving average for at least 10 weeks in a row, more often than not turbulence would ensue in the broader market:
Forward Chg in SPX After VIX Turned Contango But Remained Above 20WMA
| Date | SPX | SPX 4-Week Chg | VIX | VX1 | VX1 - VIX % (Contango) | VIX # Weeks Above 20WMA | SPX Forward Chg | 2-Week | 4-Week | 12-Week |
| 7/2/2007 | 1,530 | 1.51% | 14.72 | 15.3 | 3.94% | 11 | 0.24% | -6.36% | -0.24% | |
| 7/9/2007 | 1,553 | 1.28% | 15.15 | 15.45 | 1.98% | 12 | -6.03% | -6.37% | 0.33% | |
| 7/16/2007 | 1,534 | 2.10% | 16.95 | 17.72 | 4.54% | 13 | -6.59% | -5.75% | 1.81% | |
| 8/20/2007 | 1,479 | 1.40% | 20.72 | 22.23 | 7.29% | 18 | -1.75% | 3.14% | -1.39% | |
| 8/27/2007 | 1,474 | 2.86% | 23.38 | 23.7 | 1.37% | 19 | 0.70% | 3.58% | -2.26% | |
| 12/8/2008 | 880 | 0.74% | 54.28 | 54.58 | 0.55% | 15 | -0.79% | 1.21% | -22.32% | |
| 10/3/2011 | 1,155 | 0.11% | 36.20 | 37.95 | 4.83% | 11 | 7.17% | 8.46% | 8.84% | |
| 3/12/2018 | 2,752 | 0.72% | 15.80 | 16.275 | 3.01% | 10 | -4.04% | -3.48% | 0.98% | |
| 4/16/2018 | 2,670 | 3.16% | 16.88 | 17.26 | 2.25% | 15 | -0.25% | 1.60% | 4.91% | |
| 4/27/2020 | 2,831 | 13.74% | 37.19 | 37.42 | 0.62% | 11 | ||||
| Average | -1.26% | -0.44% | -1.04% | |||||||
| Median | -0.79% | 1.21% | 0.33% | |||||||
| % Positive | 33.33% | 55.56% | 55.56% |
In short, the VIX being in contango while trading above 20-week moving average is not necessarily bullish, considering 66% of the time SPX would move lower in the next 2 weeks. During the Great Financial Crisis, note that the 2009 March bottom came only after VIX dropped under and failed to recapture the 20WMA on the subsequent retest:
Source: WingCapital Investments
Secondary Black Swans Lurking On The Horizon
Without question, the health crisis is gradually abating in developed countries, with the U.S. and Europe getting ready to reopen their economies. Though, we reckon there will be plenty of "2nd waves" in volatility upon entering a post COVID-19 world. The most obvious one is the renewed tensions between U.S. and China who have been trading barbs over the origins of the coronavirus. Indeed, holding China accountable for the virus has increasingly become part of President Trump's re-election campaign. To wit from SCMP:
When asked about reports that he could decide to default on US debt obligations to China, Trump said he could “do it differently” and act in “probably a little bit more of a forthright manner”. “I could do the same thing but even for more money, just putting on tariffs,” he said.
Meanwhile, an emerging market debt crisis appears to be brewing due to the likes of Turkey having become epicenters of the coronavirus. As a result, the Turkish lira has "succumbed to pressure and weakened past 7 to U.S. dollar" per Financial Times. The entire Latin America likewise is in jeopardy with the virus getting out of control in Brazil and Peru, while Russia and India continue to report record number of new cases per day.
In summary, there are more than enough catalysts this month that could put an end to the massive bear market rally. Technically, the 50-day and 200-day moving average remain critical support and resistance, both of which would determine the next major move in S&P 500 once breached. We are leaning towards the bearish scenario given the likelihood of a U-shaped economic recovery.
This article was written by
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