The VIX has been in a bull flag for eight weeks now, the exact same amount of time the index charts have been in a bear flag. A high VIX equals poor market action, of course. The whipsaw created when the VIX is this high makes for very poor trading. Too many emotional decisions have to be made. Whether it goes long or short, tight stops are necessary just in case things get out of hand, and you’re on the wrong side of the trade. You get in too much and you simply get washed out, often for no good reason as the plays, which first went against you, come back strong on the next crazy whipsaw move. So less is more in markets such as these and if you play that way, you at least have a fighting chance. No guarantee, but at least a shot at winning trades. You’ll hear most analysts on television tell you traders love this type of environment. WRONG!! They hate it. It’s too difficult. They love quieter VIX readings. Less volatility so things are more in line with stability. Nothing stable with VIX readings consistently over 30, and recently, consistently. over 40. The high VIX has done something else that’s not friendly for the markets. It has established a very large trading range in the bear flag. 1101 to 1235, or nearly 12%. That’s not to be taken lightly.
Most bear flags, or bull flags, for that matter don’t offer up such a high percentage range. That also means they won’t last as long. This one is very different thanks to that VIX. If you consider that the average index only moves a few percent per week, if you’re lucky, you can understand why today was end of week eight in the bear flag. While the whipsaw is intense, the average weekly final move is only a few percent. It can be 5-6% in a given day all over the place, but again, in the end, the averages only move a few percent per week. There’s always the occasional exception of course, but even then, with the range at 12%, the market is hanging well within the bear flag. The high VIX offers up the possibility of staying in this range for a long time to come. Sorry, but that’s the way it is folks. Let’s hope week eight today is nearing the end of this flag pattern, but I wouldn’t hold my breath. The late day action says maybe we’re ready to break. Let’s hope.
If you want to be bullish on the economy you can hold onto two reports that came out late this week. The Chicago purchasing managers report came in well ahead of expectations at 60.4 vs 55.0 expected. in addition, the jobless claims numbers too a huge nose dive, and that makes me suspect since we are not hearing of any hiring, but it came in at 391,000 or about 37,000 better than expected. All I keep hearing about is 10,000 layoffs here, and 20,000 layoffs there, so this number is very suspicious to me, but that’s what was reported. I won’t argue with it. All I can say is that’s two good ones back to back on Thursday and today. Is it meaningful? We’d all like to say yes. I have to idea, and, of course, we will need a lot more evidence, such as the big manufacturing report due out Monday. The ISM is a big one to watch. It should be a major market mover. It’s been sitting on the dividing line between contraction and positive activity for two months straight. Sitting at the dividing line of 50. You get the feeling the market would like to see a nice jump back up to where 50 is not a concern short-term any more. It’ll be more than interesting. So we’ll see if the economic reports out this coming week can support the two good reports seen late this week.
The most interesting aspect of this week’s action was the massive damage done to stocks in certain parts of this market. The commodity stocks along with capital goods stocks really saw some damage. China stocks also knocked down hard as the story there seems to be pointing to a slowing economy. The moves lower were intense with high volume supporting the moves down by the big money. Distribution volume, if you will. Not what you want to see, and this supports the thesis of deflation and not inflation, the real concern for us all. Losses of trend lines and key moving averages, not to mention new lows on horizontal price. This is what we saw all over these sectors as the week ended. When these types of breakdowns occur on huge volume, reversing the damage takes a long time due to willing sellers on back tests. Add in gap down after gap down in the pattern lower and the technical damage is real. And then it will need a lot of time to heal up. One other aspect of the selling was the fact that it wasn’t only done to higher P/E stocks, but to lower ones equally as much. It was a just get me out attitude across the board. Good to see some froth get wrung out of the market, but more concerning when non-froth is treated much the same. It says big money believes the deflation trade is for real. If not, only the froth stocks would have taken it on the chin. Deflation is what fed Bernanke will now focus on, and why you haven’t see a QE 3 program yet. We don’t need stagflation, which is what could happen if he gives too much stimulus (inflation) back in to the system. Making things more expensive, while things deflate out, is never a good combination for anyone.
At some point in the not too distant future we will need to look for a major bottoming stick. The level of pessimism is extremely high. It is not a bull market. It is a bear market. A strong counter-trend bounce does not mean the market is turning to a bull. It will be necessary to unwind the extreme pessimism so the markets can fall harder once again. While we can breach 1101 here, it will be more than difficult to kill it much lower short-term unless we get hit with a barrage of bad news overseas on country defaults. If we can raise some optimism it would go a long way in allowing the market to fall further over time. The bear trade right here is quite full with bears at levels seen at the March 2009 lows. This doesn’t mean we can’t fall here to a new low that reverses up. That would be the best way to put in a real bottom, and that’s what is hoped for here. For now 1199, or the 50-day exponential moving average, is resistance, and then 1235. 1130/1120 is strong support followed by 1114, and then the key number at 1101. Again, I’m hoping for a breach of 1101 before we bottom, but you just can’t know for sure. Watching to see bottoming sticks, whatever level it comes from, but a breach would really be best. We don’t always get what we want. For now, keep things really light as the market does its daily whipsaw battle as it searches for a low.
Finally, the end of the day action was indicative of a market that will indeed head lower early next week, although news from abroad can always change that. There were no buyers today, such as we saw yesterday. The reason this is significant is because the last day of the month is where you see supposed window dressing where fund managers buy up stocks. Not today. A close on the low is what we saw today with the Nasdaq breaking down. The bear flag is barely hanging on now, and a real strong breach is possible before we get the reversal up I’m looking for. You don’t know where that’ll take place, so you want to make sure you see it first.
Don’t guess a price. Maybe it’s S&P 500 1090, or maybe it’s S&P 500 1050. You just don’t know, so don’t guess. Let the market tell us. That massive hollow candle with big volume will appear when it appears and that’s the way it is. No wishing, or hoping, or thinking. Let it show its hand. No guarantee we’ll lose 1101 S&P 500. The bulls will fight really hard if we get there again, but I think we can break and flush things out for a short-term trade higher. Again, we watch and learn, and let the market tell us when it’s time to think about a long-side period of time before going lower again.
Peace,
Jack
