The market is trying very hard to prove everyone wrong these days.
It is like a petulant child, refusing to behave in an accepted manner.
This "petulance" began with sell signals in late September, but just as
the market got rolling on the downside, it quickly reversed upward
without the benefit of buy signals or major oversold conditions. The
ensuing rally seemed strong, extending so far as to break through
resistance and downtrend lines this week, culminating on Wednesday.
That upside breakout led some to turn bullish, only to see selling with
a vengeance occur on Thursday (Figure 1). This type of action can be
hazardous to your wealth.
Even though the 2004 downtrend line was broken by $SPX and
$OEX, it apparently was not that significant of an upside breakout,
since the market collapsed right back under those levels the next day
(Thursday). What is more significant, it seems, is that there are
numerous resistance levels from the February, April, June -- and
perhaps, September -- tops. We would feel much better about the
market's chances of overcoming all that resistance if our technical
indicators were oversold and setting up buy signals, but they are not
(read on).
Equity-only put-call ratios have generally kept their bullish bias,
which means they've been declining (Figures 2 and 3). They are not
really "overbought" because the ratios are fairly high on their charts.
You can see from those charts, though, that both the standard and
weighted ratios have been oscillating back and forth over the past few
days. Hence, at this time, we need to see these charts begin to "trend"
to rise or fall in a direct manner -- before declaring a new signal.
Breadth was very strong in the most recent rally, and that pushed
breadth well into overbought territory. However,
another day of decline would push breadth over to a sell signal.
Finally, the volatility indices ($VIX and $VXO) have remained
very subdued. Both traded at 9-year lows on October 1st, and that is
certainly the definition of overbought for this indicator. While they
have risen some this week (especially during the decline on Thursday),
they are still at only about 14.50, and we would need to see them rise
above 16 in order to declare them as being on a sell signal.
Whenever markets are extremely overbought or oversold, they
don't necessarily turn around and reverse direction right away. In fact,
an oversold market can fall a great deal and an overbought market can
rise a great deal -- all the while maintaining the oversold or overbought
condition. Reflex market moves (i.e., moves opposite from the major
trend) can be very violent when the market is in such a state.
Thursday's decline might just be that. As a result, it's quite dangerous
to enter a market when it's already overbought or oversold. In
particular, we don't feel comfortable trying to buy this market -- not
unless a decline alleviates the overbought conditions in breadth and
volatility, and sets up some actual buy signals from the technical
indicators.
In summary, this is a very difficult market to judge right now.
None of the indicators are near to creating new buy signals, yet price
momentum has been strong. On the other hand, new sell signals
haven't appeared either. So, we say this is a time to stand aside,
waiting for some agreement among the various technical indicators
and having that confirmed by price action -- before taking on new
broad market index option positions.
