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McMillan Market Commentary 10/1/4


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#1 TTHQ Staff

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Posted 01 October 2004 - 08:50 AM

Stock Market

The technical indicators that we follow are mixed. We are taking a slightly negative view of the market, mainly because the price charts of the major indices are somewhat bearish. However, we are not aggressively bearish and will not be unless the majority of the indicators turn bearish.

Despite the rally in the broad market this week, the major averages are all below their 20-day moving averages -- and they are also within downtrending channels (see Figure 1). We continue to feel that, if more technical indicators turn bearish (a distinct possibility), the major averages could decline to the lower end of their 2004 trading channels. That would be approximately 510 on $OEX or 1050 on $SPX. It's hard to imagine that the major averages could rise much since there is a lot of overhead resistance -- without first establishing some major oversold conditions. At the current time, none of the indicators are close to being oversold, save perhaps the standard equity-only put-call ratio.

The two equity-only put-call ratios have deviated somewhat this week. The standard ratio has reversed upward and is now on a sell signal (Figure 2). However, the weighted ratio continues to decline and thus still on a buy signal, at least according to computer projections (Figure 3). We are seeing a number of disparate indications from related indicators at the current time.

The indicator that we find potentially the most worrisome (aside from the bearish index charts) is volatility. $VXO (implied volatility index of $OEX options) closed at its lowest level since December, 1995 (Figure 4). True, we have been saying all along that it's bullish when volatility is declining and that is a true statement. However, we have now reached levels that I consider to be excessive. The difference between the actual volatility of $SPX and $VIX (which measures the implied volatility of $SPX) has shrunk to low levels. Actual volatility is between 10% and 11%, while $VIX is about 13%. This means that either traders expect actual volatility to decline even further (unlikely) or they have become quite complacent (more likely). This means the market is about to explode. It seems likely to us that such an explosion could come on the downside. Even so, we won't have an actual sell signal from $VIX unless it rises above 16.

In summary, we view the market as modestly negative right now mostly due to the fact that the major averages have fallen below their 20-day moving averages and have established short-term down-trends within a larger down-trending channel that has lasted all year. If other indicators join in with sell signals, then the decline may take on a larger degree of magnitude.

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