A Technical Guide to SPDR S&P 500 ETF (SPY)
April 4th, 2013 at 4:01pm by Jonathan Beck -- J. Beck Investments
The SPDR S&P 500 ETF (NYSEArca: SPY) is testing the 2000/2007 highs — levels only reached at the peak of two previous bubbles.
This report looks at the last two bull/bear markets in the S&P 500 via SPY to see if there is anything to learn from the past to help predict the future as the bulls and the bears are setting to square off.
Prelude to a Bear Market: 2000-2002 vs. 2007-2009
Let us begin by dissecting some of the similarities between the prior two bear markets that culminated from the tech/telecom bubble and the housing bubble/financial/credit crises, et al.
A “negative outside month” is a technical pattern which forms when the high of one period is above the high of the prior one, the low is lower than the prior period’s low, and the closing price is below its former close. Granted there are some variations to this pattern, but the takeaway is that it is a sign of distribution. Also, the fact that it is a monthly pattern and not daily or even weekly is significant as it takes a concerted effort of investors form.
Note that in 2000 there were negative outside month patterns in January/July/September 2000 and then again in February/July 2007 forewarning the end of a bull market.
A “death cross” is a technical indicator devised using two moving averages, in which a shorter-term moving average crosses below a longer-term moving average. This is often used as a signal that the bears have taken the upper hand over the bulls. In order to avoid being whipsawed it is generally advisable to await confirmation when both of the moving averages begin to trend down. The opposite would hold true for a “golden cross” signal. Theoretically, any two time periods can be used, but when monthly (10/30) moving averages converge it is generally a sign that a major battle is going on under the surface between the bulls and the bears. In the chart below, note the death cross signals in May 2001 and July 2007. Soon after, both of the moving averages rolled over (trended down), thus confirming the subsequent bear markets.
All told, both bear markets were vicious. Back in 2002, the tech/telecom bubble was in full bloom and the Technology Select SPDR Fund (XLK) dropped 82%. By no means did this leave the broader equity markets unscathed. In fact, it took some 31 months and a 50.52% decline in SPY for the 2000-2002 bear market to run its course. Similarly, during the 2007-2009 bear market the Financial Select SPDR Fund (XLF) lost 85% of its value and SPY declined 57.40%. However, it took only 17 months. In either case, each bear market came to an end and the market began the process of healing the technical damage.
A Bull Market is Born
As all bear markets come to an end, so did these. It is typical that after powerful sell-offs, a bottoming process, rather than a single event, needs to occur before the emergence of a bull market is revealed. This is the market’s way of exhausting the sellers and in some cases can take many months.
After the tech/telecom bubble, SPY reached a price bottom in October 2002 (77.07), but it would take a higher low in March 2003 and the subsequent breakout in June 2003 to confirm that a major bottom has been put in place. A similar situation occurred when SPY reached a low of 67.10 in March 2009 as it took several months and a positive outside month pattern in July 2009 to confirm an end to this bear market. Also interesting was that as the monthly death crosses previously passed the torch to the bears, the golden cross signals in January 2003 and July 2010 passed it back to the bulls.
SPY Snaps Back Like a Rubber Band
A good analogy of the stock market is that it can act like a rubber band and the tighter it is stretched without breaking, the faster and sharper it will snap back. For example, the 31 month and 50.52% decline for SPY was followed by one of the longest cyclical bull markets in recent memory, lasting 60 months and gaining 104% through its October 2007 peak (157.02). On the other hand, the 2007-2009 bear market lost 57.40% in the span of just 17 months. In other words, the rubber band did not break, but it was stretched tighter and the bounce has been sharper as SPY has gone up 133.76% in 48 months.
So What Now?
SPY is now testing the peaks made back in 2000/2007 or the top of the two prior bubbles. At this point the bulls and the bears are likely to become very vocal. The bulls will site undervalued equities, or that this is the start of another new bull market, or “it’s different this time.”
The bears may say that there is no ground for the market to be at these elevated levels, or we are setting up for a devastating drop.
I think that they are both somewhat off base, however.
The bulls are correct that this market can still sustain somewhat higher, but wrong that this is the start of a structural bull. The bears have it right that we are headed into a deeper and more extensive decline (or worse, the next cyclical bear market), but they are off on the timing. Yes, SPY will be tested at this formidable level of supply, but the technical evidence is suggesting that although late in the ballgame, this rally can still sustain somewhat higher. For example, key daily/weekly/monthly moving averages are still trending higher; the March 2009 uptrend channel is still intact; the sector/market breadth analysis suggests a healthy market; and relative outperformance compared to many international/emerging equity markets may be forcing global money managers into the US in search for outperformance.
There are also no major signs of distribution or speculation developing, which are typical near the end of a cyclical bull market. With that said, near-term distribution is evident by the 3/25/13 and 4/01/13 negative outside days, but these may be alluding to just a normal and healthy correction before perhaps one final rally higher.
So how high is high? A breakout above the 2000/2007 peaks (155.75/157.52) could result in a number of things that could push SPY even higher. For example, it could: 1) capitulate the bears, squeezing SPY higher; 2) force the sideline money (neutral camp) into the market; 3) push underperforming hedge funds benchmarked to the S&P 500 to chase this market resulting in a performance driven rally; 4) bring in retail clients that feel as if they have missed this whole bull market and now the boat is leaving without them; 5) et. al. If any of these happen, then SPY can climb to the top of the multi-year broadening top pattern near 160 or even to the top of the 2009 uptrend channel closer to 168-170 before a major top develops.
J. Beck Investments is an independent provider of technical research for ETFs.