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Option Shark
Option Shark
Articles (5) 

S&P 500 Reaching Turning Point

August 05, 2015 | About:

So far this year, we have seen a tremendous run in the stock markets. According to most of the commonly accepted metrics, corporate earnings have been stronger and macroeconomic factors in the underlying economy have seen steady improvements. This has led many recent investors to start considering extending position sizes in equity markets even though it becomes more risky to start trading with prices at such elevated levels.

One method for dealing with this type of trading environment is to focus on the potentially bearish outlook that will gain in momentum once the U.S. Federal Reserve starts to increase its base cash rate, as this will have a pronounced impact over a number of different industry sectors. Higher interest rates will make it difficult for companies to generate the same levels of income when compared to the activity seen last year, so this is likely to create environments where profit taking and uptick selling make it difficult to generate gains in the early parts of next year.

In the chart below, we can see that the SPY has been caught in a very consistent range for most of this year. This has been confirmed in trading signals and this is helpful because it essentially tells us that the market has already identified some very clear cut support and resistance levels that can be used to develop trading strategies.

Capture.PNG

Chart Source: Yahoo Finance

Once the Fed starts raising interest rates, futures traders can sell into the upper edges of these ranges as a means for improving risk to reward ratios. So from both the technical and fundamental perspective, it makes sense to start looking at ways to establish a bearish stance in these asset classes.

Looking ahead, the best way to determine whether or not it is time to pull the trigger on these types of trades is to watch for language from the Fed which suggests a need to move back toward the 2% inflation target. This would imply that the Fed is ready to position itself in ways that are hawkish more than dovish, and this will give markets the reasons they need to actually start selling equities while prices are still trading near their highs. For many, it might appear as though we would be fighting against the main momentum in the market if investors start establishing themselves in the bearish direction. But the reality is that we are still dealing with slowing momentum in an historic bull run in stocks that has sent both the NASDAQ 100 and the S&P 500 to highs that might be unsustainable as we head into the final parts of this year.


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