Stock Market

From Mr. McMillan

The U.S. stock market is giving traders a lot of feints. Overall, it has failed to break out of the trading range that it's been in for quite some time. This range, as defined by the 1200-1245 area on $SPX, has contained both rallies and declines for several weeks. Thursday's rally was a strong one, and one wonders whether it was mainly due to quarter- end window dressing (which often reaches its zenith of activity on the day before the quarter ends) or due to a new-found strength in the underlying tone of the market itself. Unfortunately for the bulls, we're taking a 'show me' attitude here -- not being convinced of the impending upside potential unless the market can actually break out above the 1245 area (and clear the double tops there and also clear them in the other major indices as well; in fact, it's amazing how much the recent charts of $OEX, $DJX, and QQQQ resemble that of $SPX).

This current rally is the second one off of the 1200-1205 bottom (basis $SPX). Both times, the market rallied without actually getting very oversold, although this time there was an oversold condition in the breadth indicators. Currently, both breadth indicators have finally moved to buy signals -- but the NYSE breadth didn't confirm until Thursday (rather late). Hence, breadth got oversold at the bottom which is bullish -- but didn't improve much on the rally until now.

Equity-only put-call ratios have remained bullish for the entirety of this move. They turned to buy signals in early September and have remained there with little difficulty. What this is actually saying is that traders have been buying calls (forcing the ratio lower) all during this time. As long as the ratio moves lower, that's bullish. Only when 'too many' calls are being bought and the ratios begin to turn upward, would this be negative -- and that hasn't occurred yet. Volatility ($VIX) hasn't been very predictive. It has more or less followed the market, not led it, over the last few weeks. Therefore, it is also in a trading range -- as $SPX is. That range is bounded by 14 on the upside (which $VIX reached each time that $SPX was down near 1200) and has a vague lower bound in the 11.00 - 11.50 area. $VIX is sort of in the middle of that range now, so we'd just rate it as 'neutral.'

So where does all of this leave us? We have two bullish indicators breadth and put-call ratios. We have two indicators in a relatively neutral status (within trading ranges): $VIX and the charts of the major indices. To us, it adds up to further trading range activity in the US markets -- especially considering that this most recent, strong rally day was likely the result of the calendar (quarter end) rather than a true shift in investor bullishness. I expect to see sellers emerge at the 1240-1245 area on $SPX because sales there were profitable the last two times that the average got that high. Eventually, if $SPX can break on through 1245, that would change things because those sellers would turn to buyers and other investors would be drawn in on the buy side as well. Unless that happens, we remain skeptical of the rally.