McMillan

Stock Market

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 gain. 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.


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