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The stock market seemed to be under a great deal of pressure on Aug. 10.
Important support for the S&P 500 index SPX, +0.99% at 2460 had just been broken, and it appeared that a test of much more major support at 2400 was going to unfold.
But on Monday, Aug. 14, a very strong rally materialized, taking SPX back above 2460 and into its previous trading range (2460-2480). Simultaneously, a number of buy signals have occurred, including the VIX “spike peak” buy signal and the “VXST crossover” buy signal.
I found it very surprising that the market was able to put the brakes on the correction so quickly. But one cannot ignore the indicators. The upward shift had left support at 2437 — the lows of last week.
Now, we see that the market was just toying with everyone — as it is its job to do — and prices headed south in a strong way again. The support at 2437 was taken out, and the prospect of a test of the major support area at 2400 is back on the table. You can see from this first chart that the 2400 level has been important since early March, so if it were to be taken out, the entire picture would change to a bearish one.
We saw a strong rally in SPX on Tuesday, but it is merely a reflex rally in what is now a downtrend channel. Note the blue lines that highlight the lower highs and lower lows of recent activity. As long as SPX is within this channel, it is in “correction mode.” It would take a breakout over 2470-2475 to halt this downtrend.
The financial media is connecting this correction to the woes coming out of Washington, but in reality there is much more meaningful technical deterioration at work: it’s August (a bearish month, leading into the most bearish month, which is September), it’s a year ending in 7, and VIX was way too low for way too long. Those are much more important to the market than the media is allowing for.
Recent action has had the effect of increasing realized volatility so that the “modified Bollinger Bands” are widening rapidly. Recently, SPX probed down through the -3σ Band, but couldn’t get down below the -4σ Band, to set up a buy signal. The lower Bands are racing downward so rapidly now (due to increased volatility and falling stock prices) that it’s going to be hard to catch up. Even so, a close below the -4σ Band would set up a buy signal.
Even with the relative negativity of the above comments, it is worth remembering that as long as support at 2400 holds, the SPX chart will remain positive from an intermediate-term perspective.
Equity-only put-call ratios have remained bearish since early August. They were the only indicators to remain negative during the last reflex rally upward, in mid-August. So far, they have proven to be correct. The standard ratio is now racing higher, having reached the highest levels since last December.
In December, it was on the way down and was on a buy signal. Now, it’s on the way up and it won’t generate a buy signal until it rolls over and begins to trend downward. The weighted ratio is racing higher too, but not as quickly.
Market breadth seems like it is trying to get on the same page as the market and become a relevant indicator once again. The jury is still out on that. These oscillators have been very unstable and have switched back and forth between buy signals and sell signals far too frequently to be trustworthy. For the record, Tuesday’s strong rally has thrown them back to buy signals.
The cumulative advance-decline line, using “stocks only” data, hasn’t made a new all-time since late July. Thus there was a minor negative divergence with SPX which last made a new all-time high on Aug. 8. I wouldn’t consider that to be too bearish unless SPX were to return to making new highs, and the cumulative A-D line couldn’t follow. Even so, it is a departure from July, where cumulative breadth was strong and even led SPX into new all-time high ground.
There has been a bearish turn in another indicator: new highs vs. new lows. We have been monitoring these for a long time, and there has just been an endless stream of daily new highs dominating new lows.
But something has gone amiss, and now new lows are dominating new highs. This is sometimes the warning sign of a significant top. On eight of the last nine days, new lows have exceeded new highs (on the one day they didn’t, new highs only exceeded new lows by one issue). Over that seven-day period, new lows have averaged 121 issues, while new highs averaged 50. Is this bearish? In one sense, yes, because SPX is still near its all-time highs and is above support, yet new lows are dominating.
The last time we saw a series like this was before the January-February 2016 correction, which was a nasty correction before a strong bottom was eventually formed. Then, new lows had began to dominate new highs back in December 2015, before the full-fledged correction occurred.
Volatility continues to be an interesting area of the market. VIX gave a “spike peak” buy signal on Aug. 14 and has now generated another one as of today. The only previous VIX “spike peak” buy signal on the accompanying VIX chart is the successful one from last May (marked as a red “B”). The current signals are marked in green, since we don’t yet know if they are going to be successful or not There is not any particular advantage when there are concurrent, overlapping VIX “spike peak” buy signals. One is best to play just the first one and ignore the others, according to our studies.
Moreover, there was a “VXST Crossover” buy signal on Aug. 14 as well, because VXST first closed above all of the other three CBOE Volatility indexes and then fell back below VIX. If VXST closes above all of the other three again, that would stop out the previous “crossover” buy signal, but set up another one. That hasn’t happened yet.
From the VIX chart, you can see that VIX peaked once again in roughly the 16-17 area, for the fifth time in the last few months. One might feel that it is necessary for VIX to break upward over that area in order for it to be truly bearish. That’s true, but I have marked a budding uptrend in VIX on the chart, because an uptrend in VIX is also bearish for stocks.
As for the construct of the VIX derivatives, they were teetering on the brink of bearishness as well. The now-front-month September VIX futures were trading at a discount to VIX, and so were October futures. However, that danger seems to have passed, and the term structure is still sloping slightly upward. So, this indicator is bullish once again, indicating that any selloff is just a correction and not a bear market.
In summary, the market whipsawed up and back down again, taking a lot of traders on both sides out of their positions. We continue to view the short-term as negative. The intermediate-term remains positive, though, as long as SPX holds above support at 2400.
Recall that in a true topping formation, the other indicators typically give sell signals first, and the SPX breakdown below support is the last indicator to confirm. Hence, a close below 2400 should be respected as a severely bearish development.