Key Breakouts Fuel An Impressive Bounce from Oversold Conditions – The Market Breadth

Stock Market Commentary

After 8 weeks of downward selling pressure, it is hard to pivot thinking on the stock market. Yet, the technical situation requires just such a switch. While the first oversold dip of May was unconvincing, I did flip (cautiously) bullish after the stock market closed oversold for the first time in 519 trading days a week later. Trading from there still took patience as the stock market proceeded to bounce out of and back into oversold territory twice. Jamie Dimon helped sturdy the trampoline for last week’s bullish surge out of oversold conditions. This rebound is the most impressive yet given a combination of key breakouts in financial markets.

The Stock Market Indices

The S&P 500 (SPY) retested its bear market line a week ago. At the time, carnage in retail stocks convinced me to brace for a potential breakdown on the next dip. That dip, if it is coming, has been pushed out further into the future. Better retail news helped the S&P 500 gain 2.0% and push through its downtrending 20-day moving average (DMA) (the dotted line below) for the first of two key breakouts. The next day, the index drove higher even more convincingly with a 2.5% gain and another key breakout above resistance at the May, 2021 low.

I was hoping to hold on to the long side of my SPY calendar call spread, but the surge was strong enough to take out my position at the original price target. Without a decent intraday dip, I decided to wait until the coming week to refresh a position. I see a short-term runway for the S&P 500 to overhead 50DMA resistance (the red line in the chart below).

The S&P 500 (SPY) sliced through overhead resistance with a 2.5% gain. The 6.6% gain for the week makes the bear market line look like a trampoline.
The S&P 500 (SPY) sliced through overhead resistance with a 2.5% gain. The 6.6% gain for the week makes the bear market line look like a trampoline.
The weekly view of the S&P 500 (SPY) shows the relentless downward momentum that proceed last week's surge. This view also makes the 20-week moving average look like the next big test.
The weekly view of the S&P 500 (SPY) shows the relentless downward momentum that proceeded last week’s surge. This view also makes the 20-week moving average look like the next big test.

The NASDAQ (COMPQX) ran in parallel with the S&P 500’s key breakouts. On Thursday, the tech-laden index jumped 2.7% and closed just short of its 20DMA resistance. The next day, the NASDAQ gained 3.3% and pushed through resistance at its September, 2020 high. This key breakout sets up a potential run for overhead 50DMA resistance.

I flipped a QQQ call option which left a good amount of money on the table. I accumulated a July QQQ put spread to form my last hedge on bullishness. On Friday’s 20DMA key breakout, I bought a QQQ call spread. I plan to aggressively trade QQQ calls as long as the NASDAQ remains above its 20DMA.

The NASDAQ (COMPQX) sliced through overhead resistance from the September, 2020 high thanks to a 3.3% gain on the day.
The NASDAQ (COMPQX) sliced through overhead resistance from the September, 2020 high thanks to a 3.3% gain on the day.

The iShares Russell 2000 ETF (IWM) raced ahead of the other indices with a 20DMA key breakout on Thursday. Friday’s 2.7% gain puts IWM within sight of its 50DMA resistance. The gap is too small for me to comfortably trade, so I am waiting for a dip to make a play on IWM call options.

The iShares Russell 2000 ETF (IWM) finally broke through overhead resistance from its 20DMA. Suddenly, a test of 50DMA resistance is within sight.
The iShares Russell 2000 ETF (IWM) finally broke through overhead resistance from its 20DMA. Suddenly, a test of 50DMA resistance is within sight.


Stock Market Volatility

The volatility index (VIX) is still moving sluggishly, this time to the downside. Despite last week’s key milestones and bullish surge, the VIX failed to leave behind the previous two lows. Follow-through fading will confirm a new bullish phase for the bounce out of oversold conditions.

The volatility index (VIX) faded back to its lows of the month. A breakdown from here should usher in a fresh wave of the oversold bounce.
The volatility index (VIX) faded back to its lows of the month. A breakdown from here should usher in a fresh wave of the oversold bounce.

The Short-Term Trading Call With Key Breakouts

  • AT50 (MMFI) = 38.5% of stocks are trading above their respective 50-day moving averages
  • AT200 (MMTH) = 28.7% of stocks are trading above their respective 200-day moving averages
  • Short-term Trading Call: cautiously bullish

AT50 (MMFI), the percentage of stocks trading above their respective 50DMAs, roared higher to close at 38.5% for the week. My favorite technical indicator left behind the previous primary downtrend. That bullish milestone was the first of two key breakouts. AT50 closed the week at a new high for the month of May. This broadly based buying pressure sets the stock market on (short-term) bullish ground going into the Federal Reserve’s June monetary policy meeting. The market is particularly well-placed for the typical positive bias for the beginning of a month thanks to passive money flowing into the market.

For now, I assume most of the angst of the last two months has sufficiently priced in the fears from the normalization of monetary policy. Of course, outright fear of a recession could soon overshadow monetary policy fears.

An interesting key milestone came from a reawakening in the high yield bond market which is dominated by junk bonds. Economic fears translated into a persistent sell-off in this risky part of the bond market right from the start of the year. Some switch turned from panic to relief in a hot minute. For example, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) shot straight up for three days. With a key breakout above the downtrending 50DMA, HYG now looks bullish. The bond market’s rejuvenated appetite for risk augurs well for the coming days and weeks for the stock market. Note I just happened to accumulate a fresh tranche of HYG put options as a hedge just ahead of the surge.

The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) surged straight up from its 25-month low and even managed a bullish 50DMA breakout.
The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) surged straight up from its 25-month low and even managed a bullish 50DMA breakout.
AT50 (MMFI), the percentage of stocks above their respective 50DMAs, smashed the primary downtrend and closed at its high for the month.
AT50 (MMFI), the percentage of stocks above their respective 50DMAs, smashed the primary downtrend and closed at its high for the month.
AT200 (MMTH), the percentage of stocks above their respective 200DMAs, launched into its second highest close of the month.
AT200 (MMTH), the percentage of stocks above their respective 200DMAs, launched into its second highest close of the month.

Be careful out there!

Footnotes

“Above the 50” (AT50) uses the percentage of stocks trading above their respective 50-day moving averages (DMAs) to measure breadth in the stock market. Breadth defines the distribution of participation in a rally or sell-off. As a result, AT50 identifies extremes in market sentiment that are likely to reverse. Above the 50 is my alternative name for “MMFI” which is a symbol TradingView.com and other chart vendors use for this breadth indicator. Learn more about AT50 on my Market Breadth Resource Page. AT200, or MMTH, measures the percentage of stocks trading above their respective 200DMAs.

Active AT50 (MMFI) periods: Day #3 over 20%, Day #17 under 30%, Day #26 under 40%, Day #37 under 50%, Day #42 under 60%, Day #313 under 70%

Source for charts unless otherwise noted: TradingView.com

Full disclosure: long QQQ put spread and call spread, long HYG puts

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*Charting notes: Stock prices are not adjusted for dividends. Candlestick charts use hollow bodies: open candles indicate a close higher than the open, filled candles indicate an open higher than the close.

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