Another view on where we are, and where we're going, Schaeffer's Research:
What the Trader Is Expecting in the Coming Week: We're Watching VIX, 80-Day Trendline on SPX
By Todd Salamone, Senior Vice President of Research
Two weeks ago, I summarized a few short-term concerns for the market. It had once again run into long-term technical resistance ahead of an expected "post-expiration hangover," and short-term optimism was at risk of being flushed out. Are we seeing a repeat of the broad-market weakness of May-June 2009, which preceded another major buying opportunity, or is this a precursor of a more serious market decline?
As we enter this week's trading, the S&P 500 Index (SPX) sits more than 6% shy of the 1,100 level, a high the index achieved just a few weeks ago. This "hangover" is hurting more than others. Is the patient seriously sick, or is a recovery imminent? In order to answer this question, it might be constructive to step back and analyze what occurred a few months ago, as I see a similar technical pattern potentially materializing.
After a huge run higher, the market's momentum began to seriously wane as the SPX approached the 920 area, 38.2% above its March low. After a quick burst through this key Fibonacci resistance area in early June, resistance from the January highs came into play, leading eventually to a 7% correction. The 80-day moving average acted as support when the correction finally ended in the summer. As I've previously noted during the past several months, this trendline has been a key support and resistance level since June 2008.
Similarly, the market's momentum began to slow in September, as the SPX bumped up into the 1,080 area – 61.8% above the March low. 61.8 is another key number for Fibonacci followers. After a quick burst through 1,080, the market rallied into the 1,100 level, which is just below the site of a 50% retracement of the October 2007 peak and March trough. We enter this week's trading with the SPX trading just above its 80-day moving average, which will be sitting around 1,025 when trading begins on Monday.
In addition, the 80-day moving average coincides with October's low. Should the May-June-July pattern repeat, the 80-day moving average will again hold as support following a decline of roughly 7%. This would imply the patient will recover, just in time for what has traditionally been a positive period in the market.
Daily chart of the SPX since September 2008 with 80-day moving average
In early July, the percentage of bullish retail investors, as measured by the weekly American Association of Individual Investors, was at 28%. In the most recent report, only 33% were bullish, compared to 47% just two weeks ago, which was near a 2009 high. The increasing fear among retail market players is encouraging as the SPX approaches its 80-day moving average, as they have been wrongly positioned at key turning points in the market in 2009.
The biggest risks I see are in the option activity on the PowerShares QQQ Trust (QQQQ) and in the behavior of the CBOE Market Volatility Index (VIX). The International Securities Exchange (ISE) and Chicago Board Options Exchange's (CBOE) 50-day average of the buy (to open) put/call volume ratio continues to track lower on the QQQQ, declining from extreme levels. Our interpretation is that institutional money is no longer accumulating technology stocks, as they typically buy put QQQQ options to hedge their technology exposure. If this interpretation is correct, this loss of leadership from the technology area would dampen the prospects of a strong rebound. That being said, put buying relative to call buying on the QQQQ picked up nicely in Friday's trading, which is certainly encouraging.
The VIX's close above the 30 area on Friday brings both a positive and negative interpretation. The positive is that the VIX's closing high at the early-July bottom was at 31.30. Therefore, bulls would obviously like to see yet another peak in this area. But different from July is the fact that the VIX closed above both its 80-day and 160-day moving averages. Bears would argue that this puts the VIX 2009 trend lower, which would be a negative for equities. The chart below depicts the importance of the 80-day and 160-day moving averages in 2009. Bulls would like to see the VIX move back below 30, sooner rather than later.
Daily chart of the VIX since January 2009 with 80-day and 160-day moving averages
As I said at the beginning of October, if you are an aggressive short-term trader, look to add to long positions, but do so with tight stops in mind. A break of the SPX's 80-day moving average could lead to an immediate drop to the 990-1,000 area, which would equate to a 10% correction from the highs. November VIX futures are trading at a significant discount to cash VIX, which makes VIX call buying, or selling VIX put premium via spreading, a nice way to hedge your long exposure if indeed the patient is sick.
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