The S&P 500 touches highest level since the economic crisis began, but 2 indicators could point to a pullback
The S&P 500 has stormed back from the depths of the crisis in March, briefly trading in the green year-to-date (but still down from Feb. 19 highs), before closing down below the milestone mark on Monday.
“Today’s move is a bit of a breakout—we’ve been in a consolidation phase really ever since June 11, which was the day we ended that 7% pullback. We’ve really been going sideways until today,” Randy Frederick, Charles Schwab’s vice president of trading and derivatives, tells Fortune.
But for those watching the options market and volatility like Frederick, two indicators are a potential cause for concern.
The VIX, an index that tracks volatility and fear on the Street, is currently over 30—which Frederick calls nearing “high anxiety zone.” At the 30 level today, “there’s definitely some growing concern out there, perhaps about this overly-optimistic climate that seems to be out there,” he suggests. In fact, when the VIX and the markets rise together on the same day (which “doesn’t happen very often”), it can mean a downward move for stocks later in the day, Frederick says. “Today was a classic example, and it’s been right almost every time for the 7 or 8 times it’s happened.”
But Frederick sees reason to believe there may be more big swings (and perhaps even a pullback) in the near future.
“We have this sort of bifurcated list of indicators—several of them are pointing to extreme optimism,” Frederick says. Volume put/call ratios and open interest put/call ratios (for equities options) are “all pointing to pretty high optimism—the kind of optimism we saw back in January and February. That could be good and bad,” he says. (Those put/call ratios are also similar to what we saw in early June, right before the last pullback (where markets contracted about 7%), he notes.) In the short term, the market usually goes up if they are optimistic, but “there’s a point where, if they’re too optimistic and they stay there too long, then it becomes a contrarian indicator. I don’t think we’re quite there yet, but we may be there by the end of the week,” Frederick suggests.
To be sure, some of that bullishness in the ratios is likely being driven by retail investors, says Frederick, but overall “there’s no denying that they do have a very bullish slant to them at the moment.”
On the flipside, volatility inching higher than normal (tracked by the VIX) is a bearish indicator. With higher levels of anxiety on the Street, “it tends to cause things to move sharply one way or the other,” Frederick suggests.
With stocks having traded above that 3,200-mark and valuations getting very expensive, Frederick believes a 5% pullback in the coming weeks is “very realistic.”
Virus, earnings, vaccines, oh my!
Investors got some news on the vaccine front on Monday when the Food and Drug Administration “fast-tracked” pharma giant Pfizer and German company BioNTech SE’s two possible coronavirus vaccines, the companies said Monday.
Yet the headline for this week for investors is the start of the 2nd quarter earnings season—and across the board, the Street is expecting earnings to be terrible (as Fortune reported, Goldman Sachs is predicting an earnings decline of 60% for the quarter). Yet if companies report stronger earnings than expected, surprises to the upside should be enough to give stocks a boost: “That’s going to drive those stocks higher without a doubt,” Frederick says. After all, earnings are a lagging indicator, and the markets have been nothing if not far-sighted in recent months.
One thing that pulled stocks down in the final minutes of trading Monday? California Gov. Gavin Newsom announced on Twitter the state would be reimposing some restrictions, including on indoor restaurants and movie theaters as cases in the sate (and across the country) continue to spike. The S&P 500 closed down nearly 1% at 3,155.22.
Despite it all, Frederick points to a consistent truth of the market: “If people are buying now as they have been ever since mid March, it’s because they continually believe the future is going to be brighter.”