Stock Market

The post-Katrina market rally was not confirmed by our technical indicators, which caused us some consternation at the time. As we now see, that failure of bullish confirmation was warranted, as the market eventually rolled over into a severe selloff this week -- bringing the market down to levels lower than seen at the beginning of September. It seems as if the last vestiges of buying power were consumed by the artificial quarter-end window-dressing that took place over the last few days of September and the first couple days of October. From Wednesday, September 28th, through Tuesday morning, October 4th, there were a total of 36 buy programs and only 2 sell programs. However, during that time, $SPX rose strongly on only one day -- last Thursday, when there were 15 buy programs and no sell programs. When there are so many buy programs, yet the market has trouble moving higher, there is usually a negative reaction when those buy programs exhaust themselves. This week's decline was a classic example.

So where do we stand now? The market is somewhat oversold, but it has been wounded severely. We feel it is at an inflection point and will move sharply away from this level (1200 $SPX, for example). Bulls will say the market is oversold, that we are in a support area (1190-1200, basis $SXP; see Figure 1), and that the market is due for a substantial bounce off the lower end of its trading range. All of those reasons are valid, and the bulls could be right. On the other hand, bears will point out that technical indicators have worsened (see below), and that a violation of the 1190 area on a closing basis would augus for much lower prices -- perhaps 1140, basis $SPX, which is the yearly low. Again, those arguments have merit, too. One thing that is certain is that the market won't be hanging around this level for long.

Can the technical indicators shed some light on this? The equity- only put-call ratios have recently rolled over to sell signals (Figures 2 and 3). First the weighted ratio succumbed early this week, followed by the standard ratio today. It is also worth noting that the QQQQ weighted put-call ratio has rolled over to a sell signal as well. These are intermediate-term indicators and would suggest that the downside is the path of least resistance.

Market breadth was not strong during the rally and has been terrible this week during the decline. There have been 1000 more declines than advances for each of the past three days. As a result, breadth indicators are very oversold, by that is not yet the same as a buy signal.

Finally, volatility ($VIX) has spiked to levels not seen since May. At first, $VIX was just following the market -- traindg within a range, as $SPX was. But on Wednesday of this week, that changed. $VIX broke out over a row of previous tops at 14 and shot up above 15 today. When $VIX is rising, that is bearish for the market, and that's the current state. However, as soon as it peaks, a buy signal occurs. Again -- not something one wants to anticipate -- but certainly something one wants to watch for.

In summary, we expect the market to make a volatile move away from the 1200 area on $SPX.