The U.S. stock market recently roared to new all-time highs, evidenced most obviously by the Nasdaq Composite Index and the Nasdaq 100, which have been the leaders since the election.
But we prefer to use the S&P 500 Index
for our “base index,” and that has made new all-time highs as well, along with OEX, the Dow, the Dow Utilities and the NYSE Index. Small-cap indices, such as the Russell 2000, are still a small distance away from new records.
However, this brute force market strength belies sell signals and a certain amount of general negativity in many other indicators. But it doesn’t really seem to matter, as SPX remains the strongest — and, by definition, the most important — indicator of the ones that we follow most closely.
A short recounting of SPX’s recent movements may prove illustrative. First, there was the 300-point rally after the election. That led to a very modest six-week correction in March and early April. (Remember it? I can’t blame you if you don’t.)
Then, when “Frexit” fears proved unfounded, SPX gapped out of the triangle it had been in (doubly gapped, in fact), and that set the tone for the current bullish euphoria. Even the one big down day (43 points) about two weeks ago has proven to be nothing more than the bulls reloading for another push upward.
After that severe down day, SPX rose for six days in a row, more than regaining all the losses — and finally breaking out to new all-time highs, above the early March highs. Then, last week there was a modest decline that led to a very brief and successful retest of the 2,400 level, followed by another strong blast to even higher highs. That little retest of the upside breakout over 2,400 was important, though, and it confirms the breakout. That may be one reason why buying was so strong the day after.
The “modified Bollinger Bands” are rather wide, since that 43-point down day increased realized volatility and it is still in the 20-day historical calculation. Since SPX is at all-time highs, there is no traditional overhead resistance, but the +4σ Band at 2,450 might be something of a pausing point.
Technicians have another way of gauging upside movements, although I’m not sure how well this backtests: Once a trading range is broken, the target is the top of the range plus the width of the range. Since the previous trading was 80 points wide (from 2,320 to 2,400), that would make the target 2,400 + 80 = 2,480. For the record, there is support at 2,400 (last week’s lows) and roughly 2,350 (the lows of the big down day two weeks ago).
The point is that this market apparently got all the correction it needed during that six-week pause in March and April. Now the “refueling” stages are shorter — the one 43-point down day (two weeks ago), or a mild three-day correction that retested support last week. In those cases, bears or sidelined bulls have had little time to react and buy.
To the naked eye, both equity-only put-call ratios remain on buy signals. The naked eye is probably a good measure in this case, because the computer analysis programs have deemed the weighted ratio to be on a sell signal for several days now.
The problem with that is that the computer assumes there will be a reversion to the mean in daily put-call ratios, and that will make the ratio rise. That’s not a bad assumption, since the weighted ratio is trading at its lowest levels since February 2014, but it’s still incorrect. We have often bemoaned the fact that breadth hasn’t confirmed the strength of the market since the election, but that’s just a characteristic of the “Trump market” that one has to live with.
What does seem to be massively overbought, though, and thus providing that bullish confirmation is the weighted put call ratio — or even both ratios. (The standard ratio just made a new yearly low yesterday.) This has happened in the past where the computer repeatedly calls for a sell signal, merely because the ratio is “too low,” but no selling takes place in SPX.
That condition is only cured by waiting for a visible rise in the put-call ratio, which probably means that some selling will have already taken place, and you won’t be picking the exact top of the market. That’s probably just as well, since top-picking in a rising market is a very dangerous game, which is what Keynes was talking about all along.
Market breadth has been lackluster. In fact, the breadth oscillators have been such laggards that they gave sell signals last week after the market backed off a little. That was reversed with the subsequent push to new SPX highs, so those sell signals have been canceled out.
But it’s not just that. The oscillators have repeatedly failed to generate the sort of overbought conditions that normally accompany a strong breakout to the upside by SPX. They are now both just above plus-300, as opposed to recent history when the “stocks only” oscillator was nearly plus-800 on last December’s breakout to new all-time highs. It is safe to say that we are not relying strongly on the breadth oscillator signals at this time.
It is also worth noting that the “stocks only” cumulative advance-decline line has made a new all-time high three times in the past two weeks. That is further confirmation of this upside breakout to new all-time highs by SPX.
New highs vs. new lows remains a positive indicator. There was a creeping increase in new lows prior to last week’s renewed breakout, but now new highs are totally dominant. That is positive for stocks.
Volatility remains extremely low. In the intermediate-term sense, that is positive for stocks, since SPX can continue to rise as long as VIX is not in a demonstrable uptrend. The problem is that volatility got “too low,” and that generated a sell signal. Sell signals of this type are short-term in nature, but have a good track record. The most recent 43-point drop in SPX was preceded by a similar sell signal by these indicators.
In the distant past, it was commonplace for there to be repeated signals before the market fell, so we are still considering this is a valid short-term sell signal, and expect another brief, but sharp, market correction because of it.
On a more positive note, the most recent “VIX spike peak” buy signal, which was generated after that 43-point drop two weeks ago, remains in effect. We have rolled calls up, in deference to the sell signal, but we continue to hold them. When there are opposing systems, we tend to trade them both for we do not know which (if either) will be the better one.
The construct of the volatility derivatives complex remains positive. The VIX futures are all trading at premiums to VIX (which is a given, with VIX near 10), and the term structures slope upward. These are bullish signals, and they indicate that the longer-term bullish trend is intact.
In summary, the dullness that had overtaken the market may have been broken with the recent strong upside breakout by SPX. That alone would be a good thing, for it would indicate a more tradeable market.
In any case, the outlook must remain positive (certainly for the intermediate-term) since the SPX chart is now solidly positive. A breakdown through the 2,400 support level would possibly be a cause for a change of opinion, but that is not in cards right now. The only thing in contention is whether these overbought conditions will produce a sharp, but short-lived, correction.