The "post-Katrina" rally was a strong one, taking $SPX about 40 points
higher. However, it was not based on a sound technical footing, and has
run into some trouble. Nearly all of the major indices have formed a
double top on their chart (Figure 1). This is going to present a problem
for the bulls, although if the averages should now punch their way
through those double tops, it would be a strongly bullish sign.
On Monday, the final leg of the rally took place, bringing the major
indices to levels very near their August tops. Some aggressive sellers
decided, on Tuesday, that they would take a chance and sell at those
levels. It was a fortuitous decision (for them), as the market crumpled
from there -- declining for the better part of three days. The resulting
double top formation will invite more selling, should the indices climb
to those levels again. In fact, the more times it works for the sellers, the
more sellers there will be each time those levels are approached. If the
market eventually does trade above there, though, that will turn sellers
to buyers and will make support out of that level. Specifically, we are
talking about the 1242-1245 level on $SPX. That also represents a 4-
year high. None of the other major big-cap indices has performed as
well as $SPX, so the double tops on $OEX, $DJX (the Dow), and QQQQ
merely represent August highs.
Equity-only put-call ratios were slow to confirm the rally. They
finally rolled over to buy signals late last week. Moreover, they began
to "hook" back up during this week's decline (Figures 2 and 3). These
are usually reliable intermediate-term indicators, and their reluctance to
get behind the bullish case is cause for concern.
Breadth hasn't been exactly eye-popping either. The "post-
Katrina" rally was not accompanied by the expansive breadth that one
usually sees when a new bullish phase begins. In fact, the breadth
oscillators only got modestly overbought, and then fell back as breadth
was poor this week. This action actually resulted in confirmed sell
signals by both breadth oscillators on Tuesday of this week. That is
certainly a problem for the bulls as well.
Finally, volatility ($VIX) has been a little more helpful to the bulls.
$VIX has established a downtrend now (Figure 4), which is what one
would expect during a market rally. While there was some momentary
concern on Wednesday of this week as $VIX probed back above 13, it
didn't stay there and is now declining again.
In summary, these indicators remain mixed. Perhaps we would do
best to watch the index price chart as our best indicator: if it exceeds the
double tops, all is bullish. If not, then the best the bulls can hope for is
that a decline towards support (first 1220, then 1200, basis $SPX), might
be enough to get some buy signals from our recalcitrant technical
indicators. Until then, we are not recommending positions in broad
market index options. What about the bear case, you might ask? It
doesn't have technical backing right now, with equity-only put-call ratios
still on buy signals and $VIX in a downtrend, but should those things
change, then the bears may come growling out again.
