McMillan Market Commentary

Friday, March 18, 2005

Note: Please use the following link to view this week's charts:
http://www.optionstrategist.com/products/advisories/hotline/charts.asp
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Stock Market
For the first time since last October, the broad market indices have broken down -- violating the major trend line that had identified the bull market. This is a very negative development and should be heeded. While everyone recognizes the severity of this breakdown, there is disagreement among analysts on how severe it is. Some think the market is in a trading range (bound by the January lows and the February highs; blue lines on Figure 1), but we think it could be the beginning of a more severe decline. The failure of the upside breakout two weeks ago, coupled with the violation of the trend line (red line, Figure 1) add up to a potentially large "negative," in our opinion. What will be the determining factor between "downtrend" and "trading range," of course, will be whether the market can hold at or above January's lows.

Equity-only put-call ratios remain on sell signals (Figures 2 and 3). They are accelerating upward right now, and they have plenty of room to go before they might be ready to generate buy signals.

Breadth (advances minus declines) has been dismal for over a week now. That has pushed both breadth oscillators into negative territory. In fact, the NYSE-based oscillator has fallen faster than the "stocks only" and it is officially oversold. However, "oversold" does not mean "buy." The "stocks only" oscillator has not yet reached oversold territory. The oversold condition of these indicators reflects the fact that the broad market might also be oversold. However, while that might mean that sharp, short-lived rallies are possible, it is worth remembering that the market can decline sharply when it is oversold.

Finally, there is volatility ($VIX). It has remained rather dormant refusing to climb above the 14 level. Perhaps this means that we are in a trading range, but it is not without precedent for $VIX to remain low while the market makes its initial decline. Look at the circled area on Figure 4, which depicts what happened just about one year ago: the market had declined but $VIX was not moving higher. Then, the market went into a further, more accelerated, decline, and that caused $VIX to finally spike higher -- eventually giving a buy signal on that spike. So, we think that this market will move lower and will eventually see $VIX spike up as it does.

The bottom line is that we view the breaking of the uptrend line as significant, especially in light of the other negative indicators.


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