For a market that is exhibiting implied and historical volatility in the
10%-11% range (i.e., not volatile), there is certainly a lot of action. This
week saw two upside reversals (Tuesday and Wednesday) that were
earnings-propelled, but spread into a lot of groups (technology, biotech,
transports). The option activity accompanying those strong upward
moves was speculative and huge in terms of volume. Then Thursday, the
market swung back and forth in wild fashion -- first rising on China's
decision to float the Yuan, then plunging on new fears of a bomb in
London, then recovering those losses before succumbing to more selling
that pushed $SPX back to the lows of the day, by day's end. It's
exhausting just writing about it. But, wait, there's more! Google
(GOOG) reported earnings after the close Thursday. First, it plunged
from 313 to 293 (a drop of 20 points), then rose to 322 -- all in a matter
of minutes -- before starting another decline that terminated at 280 and
then rallying back to about 295 late in the after-hours session. All in 2-
hour after-hours session. Now that's volatility!
Figure 1 shows the $SPX Index. The rally caused by China's
monetary decision is marked is red (dotted line) because it actually
occurred before the US markets opened. While it's possible that this
marked the end of the rally -- a spike peak -- we don't think so. The
technicals remain strong and, even though various indicators are
overbought, we don't expect much more than minor corrections unless
some more serious sell signals arise. $SPX is trading at its highest prices
in 4 years. $OEX, $DJX, and QQQQ can't make that claim (although
some small cap indices, such as Value Line, are actually at all-time
highs), but they have overcome some resistance levels and have a
generally positive tone. Right now, support for $SPX is in the 1205-
1210 area, so it's bullish as long as it stays above that.
The equity-only put-call ratios have given buy signals (both of
them) and have maintained them this week (Figures 2 and 3). They will
remain on these buy signals until the ratio bottoms out and begins to turn
upward.
Meanwhile, breadth has been positive as well. On days when the
market rises, advances have dominated declines.
Finally volatility indices ($VIX and $VXO) have recently plunged below
the levels of December, 1995. They got down to levels last seen in
January and February, 1994 -- and are very near the all-time lows set in
1993. Thursday's decline pushed them slightly higher, but we wouldn't
consider $VIX to be perilous for the market unless it rose above 13.
Overall, this market is overbought. $SPX is extended; breadth
is expansive; and $VIX is near all-time lows. In addition,
we look at lots of stock charts daily, and many of them are extremely
over-extended now. The number of new highs or new relative highs is
astounding, and usually stock (and sometimes option) volume patterns
are confirming as well. While these stocks may go higher after
pullbacks, they are overbought short-term (see GOOG). However, an
overbought market can continue upward -- sometimes rapidly -- just as an
oversold market is actually quite dangerous, for large declines can occur
when it's oversold. So, while an overbought condition is often the
harbinger of a sharp, but short-lived correction, we wouldn't turn bearish
unless some real sell signals were confirmed. Currently, that doesn't
seem likely -- save for perhaps breadth sell signals. Hence, we retain a
bullish bias until our indicators tell us otherwise.
