To The Moon

Hi everyone! Today, we’ll look at an ETF that everybody knows:

SPDR S&P 500 ETF Trust (ARCA: SPY)

Just a quick overview of where we are right now - we were trading in a large descending channel (blue trendlines), that we broke out of recently. Well… I’m pretty sure you know what comes next. Most times, stocks come back to test their breakouts. An ETF, which is a basket of stocks, is no exception to this.

Notice how SPY is forming a three-legged bearish divergence with an overall decrease in volume over time. This is indicative of (gradual exhaustion) and an imminent trend change for the short term. What’s also interesting is that SPY failed to make a higher high during Friday’s session. This is indicative of short-term exhaustion and downside. A channel could most likely see a bounce at 491.62, which has held as support several times.

Something else I noticed is that SPY is holding an orderly series of higher lows on RSI. I’ve gone back and realised that this pattern of lower highs and higher lows has tended to cumulate in a breakdown to form a lower low on RSI. This has usually resulted in either a pullback or a significant correction:

From the ones I could discern, this has occurred 6 times in the past 6 years.

However, for the trend to properly reverse for the short-term, and for us not to be overly reliant on the bearish divergence, I need to see a few things:

(1) The green trendline we are holding (series of higher lows) on SPY’s price action itself needs to break, and we need to form a lower low. We should then have a tradeable bounce to backtest the breakdown before it heads lower.

(2) RSI needs to roll over and form a lower low. That usually precedes a significant move lower in the short-term.

Another thing worth noting is that on the higher timeframes (monthly, quarterly), the chart is still bullish. While the weekly painted a hanging man, there aren’t any significant divergences in play yet. That being said, I am continuing to monitor this potential long-term bearish divergence on the monthly chart:

Dubbed my “Grand Theory”, it suggests a major pullback once we form the third lower high. Note that monthly RSIs take a very long time to play out, so this move down might not happen for another year or two. But it does warrant caution. The higher the timeframe of the divergence, the “stronger” it can be if it plays out. SPY has to form a higher high on RSI to invalidate the theory, otherwise it continues to be plausible beyond doubt.

With regard to upside, I’m looking at 2 levels to determine a possible endpoint. The first is the 1.618 Fib extension at around 507, based on the 2008 GFC swing low at 67 to the pre-COVID high at 339:

Image

The other is around 522, and is the 1.618 Fib extension at around 522, based on the SPY inception price at 42 to the pre-COVID high at 339.

One of these levels is likely to induce a significant pullback - maybe we hit both, which would be enough to run the monthly RSI higher to form the third leg of bearish divergence.

But I digress.

Back to the short-term. I expect SPY to retrace at least 38.2% of the move (~467). But knowing how SPY tends to be stretched to extremes, I wouldn’t be surprised if we head towards the 61.8% Fib retracement (~445, assuming we have topped near-term) and base above the bullish island gap. Post-RSI breakdown, I’m expecting RSI to move towards <30 (oversold levels, which are usually reliable on SPY).

Seasonality also supports the bear thesis.

S&P 500 Index Seasonal Chart

Source: Equity Clock

Notice how mid-February to mid-March is considered a seasonally “weak” window which tends to produce negative returns. It would not surprise me if we get a pullback during this window.

Another factor to consider would be CNBC’s Fear and Greed Index, which is a very strong contrarian indicator:

Source: CNBC

The index continues to sit at Extreme Greed, which can be construed as a euphoric signal. Shorting extreme greed and buying extreme fear has been a sound strategy for the past few years, and is likely to continue being the case.

All in all, going long here warrants caution. I wouldn’t be putting in a large section of my portfolio into the market now, when I probably have the chance to do so at better prices and valuations.

Sentiment: SELL

Summary (with Price Targets - NFA):

• SPY warrants caution with bearish divergence forming on it. A breakdown of the higher low pattern on RSI is likely to result in a pullback (most likely scenario, considering seasonality) to retest the breakout around 445.

• Near-term price action is indicative of a retest of 491, based on the possible consolidation channel it is forming. A breakdown of the higher low ascending trendline (in green) on SPY will trigger a move lower and cause the bearish divergence to play out.

• Long-term investors in SPY can consider waiting for more attractive prices on SPY before performing DCA, while newer investors can consider waiting for sentiment on SPY to turn extremely bearish (i.e. Extreme Fear) to begin investing in the broad-based index.

• Seasonally weak period for broad-based indices is between mid-Feb and mid-March, and sentiment is at Extreme Greed. Going long right now warrants significant caution.

Alright, that’s all for this newsletter. Today’s a public holiday in the US so the markets aren’t open. However, I’ll see you on Tuesday!

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