The Fat Pitch: Weekly Market Summary

Summary: the trading range for SPY is tighter now than at any time since December before a 5% drop. SPY's trading range is likely to expand and, on balance, it seems more likely that the expansion will be to the downside rather than the upside. That has been the most common outcome in the past and there are a number of supporting reasons to suggest that it will be the case this time as well.

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SPY and NDX both made new highs on Monday, then proceeded to fall for most of the rest of the week. For the week, NDX lost 1.3% and SPY lost 0.4%. RUT was the clear loser, dropping 3.1%.

Overseas was no better. Europe lost 3.4% and EEM lost 1.6%.

Crude gained 3.2%. It has rallied 6 of the last 7 weeks.

The pattern of making new highs and then giving back all of the gains continues. NDX has not been up two weeks in a row since mid-February. Over the last several weeks, SPY has lost 2%, gained 2%, lost 1% and gained 2% and now lost 2% into the past week's low on Thursday.

Through all of this, little progress is being made. For the first 4 months of 2015, SPY is up just 1.3%.

Despite the moves up and down, the trading range in SPY is now tighter than any time since mid-December before a 5% drop (lower panel). The time before that was in mid-September before a 10% drop.

Most of the time, the range expands to the downside (blue dots in the chart above). VIX goes higher (middle panel). However, sometimes the range expansion in SPY is to the upside; that is what happened in late-May into June (green dot). VIX in that case fell.

Objectively, the indices could go either way, but we think the more likely outcome is down, for several reasons.

First, the fact that the indices can't seem to hold onto and build on its gains indicates that the uptrend is tiring and in need of a reset. There are a number of reasons for this, one of which is investor sentiment. To use Investors Intelligence (II) as an example, the number of bulls has outnumbered the bears by 4 times for much of the last year. It was never this high during most of 2013 when SPY gained 30%.

Cases when the II bulls were more than 4 times the bears are highlighted in blue below. SPY moved lower shortly thereafter in 4 of the last 5 instances (lows shown in red).

In late 2013 and mid-2014, SPY moved up for several weeks first. Both times, however, all those gains were given back in a subsequent sell off. Should SPY move higher now, those gains are also likely to be fleeting as investors become ever more bullish.

Of note is that corporate insiders are selling their shares to an extent not seen in more than a year. The last two times that selling was nearly as great as now were late-June 2014 and mid-February 2015; SPY rose further both times but then fell roughly 5% within a month (chart from Barron's; hat tip to Helene Meisler).

Second, market internals are deteriorating. The chart below looks at breadth in SPY and it's clear that it has been waning as the market has struggled to move higher. This means fewer companies are pushing the index up. The normal pattern is that breadth washes out lower; this clears out the bulls and sets up the next leg higher in the market.

Breadth has now gone more than 6 months without becoming oversold. In the past 5 years, SPY has never gone longer than 6 months before peaking and falling into a period where it becomes oversold (blue shading). Similarly long rallies are shown below. This one is now the longest.

Third, 1 month relative to 3 month volatility is dropping to a low from which it has been close to reversing (lower panel). Each time in the past 3 years, SPY has either traded lower (the last 4 times) or sideways with any gains given back within a month (shading). So, any rally now is quite likely to push this ratio down where a reversal becomes high odds.

We can add one final reason the tight range in SPY is likely to resolve to the downside: the period of strong seasonality ended in April. The markets now enter what is referred to as the weakest 6 months of the year. To be clear, returns between May-October tend to be positive (left column); what is noteworthy is that the probability of greater downside increases significantly during the summer period relative to the winter (middle column; chart from BAML). Read further here.

In summary, the trading range for SPY is tighter now than at any time since December before a 5% drop. SPY's trading range is likely to expand and, on balance, it seems more likely that the expansion will be to the downside rather than the upside. That has been the most common outcome and there are a number of supporting reasons to suggest that it will be the case this time as well.

For the coming week, note that SPY has been in a rising channel for more than a month. This past week, there was a fake breakout higher on Monday (arrow) and then a fake breakdown lower on Thursday (yellow shading). Friday's recovery puts the index back in the channel.

As the saying goes, "from false moves come fast moves," so there's a possibility the fake move lower has created the impetus for SPY to trade above 211 resistance (horizontal line) and then to the top of the channel (214 area).