The negative market tone that appeared right at the beginning of the year has not abated. Even worse, the tenor of this decline is taking on some of the nastiest traits of a bear market. For example, a bear market is punctuated by sharp, short-lived rallies that have no staying power -- but these rallies give the bulls false hope and scare the heck out of the shorts. That's exactly what happened Tuesday when the market rallied strongly, breaking out over what had appeared to be resistance. But those gains and more were lost on Wednesday and Thursday, as the major averages all made new lows for the new year. This volatile action has made it very difficult to discern reliable support and resistance levels, but from the chart in Figure 1, you can see that the declining 20-day moving average did contain the advance and thus might act as resistance on further rallies.
The equity-only put-call ratios wavered slightly on Tuesday's rally, but then shot higher with a vengeance the last two days, as the decline in the market resumed. These ratios (Figures 2 and 3) are heading straight up and that's bearish. Only when they roll over and begin to turn down will they generate buy signals. That doesn't seem likely soon.
After the first three, very negative, trading days this year, market breadth had been improving. In fact, Tuesday's rally had very strong breadth. However, the last two days have displayed very negative breadth and so we're viewing breadth as "neutral" right now until it moves to one extreme or the other.
Finally, volatility has been difficult to interpret recently, but we think there is one perspective in which it's been useable: as a short- term indicator. For example, $VIX rose sharply on the last two trading of 2004, and then the market collapsed. Subsequently, $VIX languished while the market probed its lows. Thus, in that case, $VIX wasn't "worried" and a rally soon began, culminating on Tuesday. That's the day that $VIX gave its next subtle signal: it didn't decline on Tuesday's big rally. That was very unusual and was a bearish signal of sorts. By itself, though, that particular day wouldn't have been noteworthy for $VIX. It's what happened next that adds more significance: as the market declined on Wednesday and Thursday, $VIX moved higher as confirmation. I am interpreting this as a modestly bearish sign. But we still won't declare $VIX to be on a sell signal unless it closes above 14.20. Note, in Figure 4, that if $VIX moves above the recent highs, it will have made a "higher high, higher low" pattern, which usually leads to further moves on the upside.
