The stock market has been in a slumber since gapping up above a modest downtrend line on July 12.
From July 13 to July 26 — 10 trading days — the VIX VIX, -0.29% closed below 10. On five of those days, the S&P 500 Index SPX, -0.07% closed at a new all-time high. And on seven days, the benchmark index traded at a new intraday record. So the market has been advancing slowly and methodically, but in doing so has created a severe overbought condition, especially in terms of volatility indices. More about that later.
As far as the S&P 500 chart goes, though, it is unabashedly bullish. It continues to make new highs, remaining above the trailing moving averages and holding above support. In fact, July 23’s reversal low near 2,460 points, along with previous lows near 2,465, makes the 2,460-2,465 area a bona fide support area now. Below there, support exists at the old highs of 2,450. Then the most important support area is still at 2,400. Note that a sharp, but short-lived, correction could develop from current levels and still not take out the support at 2,400 — meaning that the intermediate-term outlook is still bullish, per the S&P 500 chart (our most important indicator).
As for upside resistance, there isn’t any in the classic sense, since the S&P 500 is trading at new highs. However, we did have targets of 2,480-2,500 based on the breakouts from previous trading ranges. (The breakout from the 2,320-2,400 range gave us a target of 2,480, and the breakout from the 2,400-2,450 range gave us a target of 2,500.) The S&P 500 has only just recently traded above 2,480, but has yet to close above there.
Furthermore, for the past several days, the S&P 500 has crawled up the +3 “modified Bollinger Band” (mBB). That is not an imminent signal, but if it should close above the +4σ Band, that would set up a sell signal. You can see from the two previous mBB sell signals (marked with the letter “S”) in figure 1 that the market at least stalled out for about four to six weeks after the sell signal. Currently the +4σ Band is at 2,487 — very near the middle of our target range.
So, the S&P 500 chart is positive, but it could be running into a zone where it is going to encounter some trouble continuing the advance.
Equity-only put-call ratios remain bullish. The standard ratio has developed a little “wiggle” over the past few days, but at this point the computer analysis programs are still grading this chart as being on a buy signal. Meanwhile, the weighted ratio continues to make new relative lows daily and is thus solidly on its buy signal at this time.
Market breadth is only mildly bullish. The breadth oscillators have been on buy signals since July 12, but were never able to register the kind of strong overbought reading that we like to see when the S&P 500 is breaking out to new highs. Now, with some recent slowing action in breadth, both of those oscillator buy signals are in jeopardy. Even a day of modestly negative breadth will roll them back over to sell signals. As we’ve noted many times since last November, breadth has just not been strong enough — in either direction (no “90% days,” either “up” or “down” since the election) — to keep these breadth oscillators from flip-flopping back and forth between what have become relatively meaningless buy and sell signals.
A more positive tone is connoted by the fact that the cumulative advance-decline lines have been making new all-time highs, and that is supportive of the S&P 500 new all-time highs. The “stocks only” cumulative A-D line has made new all-time highs on seven days since the last upside breakout by the S&P 500 on July 12.
New highs vs. new lows is also a positive indicator, as new highs continue to dominate new lows. Since that upside breakout on July 12, new highs have averaged 177 per day, while new lows have averaged 16. That is dominance, and it means that this longer-term indicator is still positive.
So now we reach the subject of volatility. It is so low that it has been analyzed, re-analyzed and cross-analyzed by every commentator and media “expert” on TV, radio and the internet. What can one say, besides the fact that when VIX is low, stock prices can continue to rise — and they certainly have. As noted earlier, VIX had recently closed below 10 for 10 consecutive days. That is a record, shattering the previous record of six days, when the “old” VIX VXO, +4.72% was extremely low leading up to, and including, the Christmas holiday in 1993.
VIX closed at new lows for the entire life of this and previous versions of VIX that date back to 1986. That’s a pretty amazing stat right there. Other volatility indices, such as VXO (also dating back to 1986), VIXMO, VXST, etc., have recently traded at, and closed at, new all-time lows.
Short VIX trading systems are having a heyday (one such trader posted his returns through June as +36% year to date — he’s essentially long XIV (the inverse VIX ETF), plus long some bond ETFs). But these are volatile, as XIV was down intraday over 7% just last Thursday, before recovering with the broad market. There are many other variations of “shorting VIX,” and they have all made good money this year. But there are going to be some large drawdowns when VIX reverses. On the other side of the coin are those looking for an explosion in VIX and thus are buying VIX calls or taking other positions designed to profit if VIX takes off.
This is all being driven, of course, by massive selling of SPX puts — lowering their implied volatility (that’s what VIX measures). VIX has traded down to very near the 20-day historical level of SPX itself. That 20-day historical vol is at about 8%, and VIX has been just above 9%. It is unusual to see VIX trade that close to historical vol (usually it’s higher than that), especially at these low levels of volatility. But that’s the way it is, and until something shocks these VIX sellers and SPX put sellers out of their somnambulant state, that’s likely the way it will remain.
Clearly VIX is in an overbought state, but as we all know, overbought does not mean “sell.” So where would we sell? We are still rather arbitrarily using 13 as the demarcation line for VIX. If it trades above there, and especially if it closes above there, the wheels could begin to come off of this bullish stock market bandwagon. Until then, the bulls will have their way. Remember Keynes’ admonition that “the market can stay irrational for longer than you can stay solvent.” After that long period of low VIX in 1993, there was something of a market correction a few months later, but VIX remained below 20 for the most part for another two years after that.
The construct of the volatility derivatives remains bullish, and that is an intermediate-term indicator. The VIX futures are all trading at premiums to VIX (although considering that VIX is so low, one might think those futures premiums should be even larger). Moreover, the term structures of the VIX futures and of the CBOE Volatility Indices continue to slope upward. Those are bullish indicators.
In summary, all of our indicators continue to be bullish, although some (breadth, especially) are not far from rolling over to sell signals. Of this bullish lot, the most important is the chart of SPX, and as long as that is bullish, the intermediate-term outlook is positive. The overbought condition in volatility warns of a sharp, but likely short-lived correction, and that is probably imminent. But that won’t change the intermediate-term picture unless the major support levels of the S&P 500 are taken out.