Thursday, May 12th, 2005
Stock Market
In the last couple of weeks, the market overcame resistance at 1165 (basis $SPX) and moved higher, before running into severe trouble at the 50-day moving average. This is very similar to what happened back in early April -- a rally was unable to break through the 50-day moving average. That failure turned into a rout on the downside. Even though some of the other indicators are positive, this failure to break out has resulted in a very nasty retracement. The market bulls are now being put to a severe test. They must rally immediately, or the whole picture will turn bearish. Any close below 1158 ($SPX) would destroy the bullish case.
We had mentioned some time ago that the market's most devious course of action would be to break out over 1165, thereby trapping the shorts, then to turn and make new lows, thereby trapping the bulls. There is a distinct possibility that this scenario could fulfill itself.
The chart patterns of the major indices are rather muddled right now. An upside breakout over the 50-day moving average (1182, basis $SPX) would definitely be positive. However, that seems to be a remote possibility now. More likely, there will be some test of the lows (circa 1140, basis $SPX). If they don't hold, then a whole new round of selling will be necessary before another bottom can be built.
One positive, though, is the fact that the equity-only put-call ratios are at extremely high levels now and appear to be rolling over to buy signals (Figures 2 and 3). Even Thursday's negative action did not move them back to new highs. Of course, they had similar patterns just a short while ago, but did not give buy signals at that time. Frankly, the failure of these trustworthy indicators to give buy signals (at least, thus far) was one thing keeping us from becoming bullish earlier this week.
Market breadth has been giving some good short-term signals of late. In a truly bullish environment, breadth would have gotten very overbought as the market rallied, but it did not. At the current time, we have to continue to grade them bearish.
Volatility ($VIX) has technically been on a buy signal since it made a spike peak at 18, nearly a month ago. However, we do not expect $VIX to drop back to the lows near 11 anytime soon. In fact, if $VIX starts to build a new uptrend, that would be bearish, and with today's close above 16, it may be doing just that. A trend line has been drawn on the chart in Figure 4. We are considering $VIX to be modestly bearish as long as that trend line remains intact. And, if $VIX makes new highs, we would consider it outright bearish.
