Has the Downtrend Run its Course for the Time Being?

Has the Downtrend Run its Course for the Time Being?

Posted On May 31, 2022 1:16 pm

While I still think we’re in the midst of a bear market, it’s important to acknowledge the historical data suggesting that stocks could have a strong second-half performance this year.  In other words, keep a flexible approach.  In the words of the famous economist John Maynard Keynes: “When the facts change, I change my mind.” 

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For now, let’s put aside predictions regarding inflation and the Fed’s commitment to combating it. However, we should acknowledge that some of the impetus for the recent rally was believing that the Fed would pause in September after just two more hikes.  We’ll know more after its next meeting in June. 

That said, here are some signs that the downtrend may have run its course for the time being and we could see a trend higher in the next few weeks. 

1) May 20 marked a key reversal; a new low, but a close above the previous day’s high. 

2) This was also a reversal bar on the weekly chart.

3) A volume increase during last week’s rally since the start of the trend

4) May 27 was a big gap back above the 200-day moving average

5) Five (and counting) consecutive up days. 

6)Improving breadth and few new 52-week lows vs new 52-week highs. 

7) The VIX pulled back by over 20%; well below the 30 level. 

All told, this is the first time in months that rallies in broad indices and individual stocks have not run into a wall of selling. 

If we use the rally during the last two weeks of March as a template, we can set the SPY upside target to around $435, which also coincides with major resistance. 

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spy spdr etf 500 chart 2022

Two key pieces of data that are tempering my short-term bearishness are:

1) When stocks suffer a double-digit loss during the first half of the year, they typically have positive returns during the second. Of the 9 instances when the S&P was down by over 10% during the first 100 trading days, it averaged a +19% for the remainder of the year. 

The key exception is the 2000 post-dot.com bust, which I think this period most closely parallels. 

2) Of the 29 instances when stocks gained over 5% in a week  (the SPY gained 6.9% last week), they go on to have an average positive return of an additional 7% over the next four weeks. 

I noted last week that the Options360 Concierge Trading Service moved to a more neutral stance, initiating some iron condors and the use of only moderately-biased calendar spreads. I don’t want to become a victim of recency bias. However, given the recent action in the context of historical data, I probably need to further retract my bear claws for the time being. 

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About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.