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Big picture look at the SPX and VIX

February 10, 2010
tags: ,

I’ll follow up on my last post on the Dollar strength soon.  But for now, a big picture look at “The Market” is long overdue.

We all know that the turnaround off the March low was fast and furious.  Then we had some very constructive consolidation during the summer until July kicked off a rally of further conviction which gradually lost momentum until finally topping out in January.  All things considered, it has been a fairly orderly run.  Likewise, despite the general public feeling of nausea related to all things financial and market-related, the recent pullback appears to be just that and can be seen as orderly and even healthy to the big picture.  After all, healthy markets need to go in both directions in the shorter term to reach their destinations in the longer term.

The S&P 500 is currently in a somewhat precarious spot of being between the 200 and 50 daily moving averages.  The positive is that the 200 MA is now steadily rising after turning upward following the July rally.  Though the 50 MA is beginning to roll over, the rising 200 MA holds more significance as the longer term representative.  This is a likely area of support in the near term.  Notice that the 200 MA is just entering the 1020s, an area that served as resistance in late August and then twice as support in early October and early November.  Also noteworthy is that the recent low three weeks ago, almost to a T, hit the key 38.2% fibonacci retracement of the recent long term rally from the swing low in June to the January high.  Fans of technical patterns might also like to see the recent action and resulting descending channel as simply a bull flag on the long term, a likely setup for bullish continuation.  Bullish divergences between Price(lower lows) and the MACD historgram and Stochastics (higher lows) would support that perspective.

The take-away from this view for me is that, a bounce of some kind can be expected soon, but the market is pulling back at the moment and will continue doing so until it isn’t.  The objective ways of determining when it stops falling are to see a cessation of lower lows and lower highs in price or a flattening or turning upward of a short term moving average (I like the 8 day exponential moving average).  Obviously, I’m looking for that to happen somewhere at or before the 200 MA.  The potential bounce or resumption of the bullish movement would be signaled by the emergence of a higher high and backed up by higher lows, a break of the downward trending resistance line, and of course, the turning up of your favorite short term moving average.  The main point of all this is to keep it objective and not emotional or an attempt at predicting the future.

Now to look at things on a bigger, longer scale.  I’ll forgo any attempt at macro economic speak other than to say that the unemployment situation seems horrible and unlikely to provide any substantial catalyst for optimism any time soon.  Friday’s report of a decrease in the unemployment rate to 9.7% from 10% coupled with another 20,000 jobs lost defies my application of logic to the subject.  What’s worse, this article shows evidence of a much higher real unemployment number at 18%.  (Mommy, make it stop!)

Back to the chart.  The SPX long term weekly chart shows a failure to successfully overcome the 50% retracement from the top in 2007.  Notice how long it took for that market top to unfold.  A good 8 months or so before it finally broke down.  We have hardly put in any type of meaningful topping structure in the last few months.  One could argue, of course, that we’re now finally getting back in sync with the long term bear market, as is supported by the resistance line across the long term swing highs which we recently peaked above before falling back.  Indeed, after the relentless upward march since March (sorry, couldn’t resist), it seems this market may just be a bit over-baked.  However, as one last argument for attempted strength in the short term, notice that the MACD lines are still on the bullish side of the zero line and the Histogram shows only a small degree of downward momentum.  Furthermore, the faster Stochastic line is oversold and looks to want to turn upward out of that zone(Notice the last time that was the case).  Finally, it is noteworthy that on the weekly view, despite the last few weeks of ugliness, we still see higher highs and higher lows.  A weekly close at 1030 or below will change that with an equal or lower low.

Speaking of Fibonacci levels, the 61.8% level is said to be the “Golden Ratio.”  A move up to that level, a full 160 points higher, would still fit within the context of a big bear market and not upset the momentum, ratio-wise.

Meanwhile, for all you true market heads, the VIX has given us a few warning cannon shots across the bow in recent weeks, and for the first time in quite a while, put in a higher low on the daily chart (higher high too, but only using intra-day action. No daily close higher.).    But we are still just above the middle of the range set from the big spike in volatility during the late October swoon.  One would think, comparing the sell-off since mid January with that of late October, that we should be higher on the VIX if the market was really that perilous.  We’re talking about a top to bottom move recently of just over 9% versus about 6.5% in October.  A sustained move above 30 is when it’s time to really start sweating about the long term nature of things.

I had thought for a while back in early ’07 when the VIX was dancing with the 10 level that perhaps the indicator was becoming obsolete.  The influence of advancements in trading technology, high frequency trading, ever more types and uses of derivatives, whatever, might be turning the VIX into a relic from another market of days gone by.  (LOL – way back when, into the ’90s!)  But with the market meltdown of Fall ’08 sending the VIX to levels that many never thought conceivable, I am inclined to think that it’s still as relevant as ever.  In the end, the most important and useful aspect of the VIX is not so much the actual number it currently shows, but where it is relative to its recent range.

Judging from this chart of the VIX as far back as I can get data for, we are now just about in the middle of what seems like a “normal” range.  To me, this signifies a somewhat healthy level of fear and indecision among market participants, where the bulls and bears are equally confused and therefore more likely to have an orderly struggle.  I hope that make sense.  What I mean to say is that up or down is fine, but all-out panic-selling or buying out of “irrational exuberance” is no good for a functional and healthy, trustworthy market, regardless of its direction.

In conclusion, I don’t like the smell of things at all.  Obama’s promise of “Change” has seemingly brought little more than an overly optimistic if not ignorant degree of “Hope.”  (Ever heard of “Hope-ium?”)  He sure talks good (cue scary Deliverance music).  It’s the doing part…What IS he doing?  The government seems as dysfunctional as ever, the unemployment picture looks terrible, we’ve been hearing about commercial real estate being the second shoe still yet to drop for months, and the nation’s deficit seems to be building like a tower of Jenga that will inevitably bring the game to a crashing conclusion.  That said, the market is a forward looking mechanism and seems to defy reason more often than not.  There is, perhaps, a healthy level of fear among the crowd.  Judging from this surface-level look at the US markets as represented by the SPX, barring a clear disaster or some catastrophic catalyst in the global markets, I would think stocks may float a touch lower in the near term, but nothing drastic.  The picture from the daily chart shows the potential for a move higher, but my guess is that we’ll find selling pressure in the 1110 area and that will be the true test.  A failure there and we’ll talk.

My best prediction is that we’ll be in a range between 1030 and 1150 for months to come.  Stock-pickers, start your engines!

Lagniappe:  Bullish Sentiment Drops to Lowest Levels since March

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