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By Lawrence G. McMillan

The specter of a false upside breakout has come true, and that could prove to be a major problem for the market. In late January $SPX broke out over 4100, and it looked like the bull market was ready to return. However, the breakout only reached 4200 before prices turned south again. Now, $SPX has fallen below short-term support at 4060-4070, which in my opinion, completes the false upside breakout scenario.

There is resistance overhead from 4100 all the way up to 4200, and then 4300 above that. On the downside, there is support at 3900, and then again in the 3760-3850 area where $SPX traded for the last half of December. A violation of 3760 would mean that the bear market is back in force, full-fledged if it isn't already.

Equity-only put-call ratios are on or near sell signals. The weighted ratio (Figure 3), has fallen to a low level on its chart and then turned upward. That is, it was in deeply overbought territory, and now it has generated a sell signal. The computer analysis programs agree that this is a confirmed sell signal for the weighted ratio. The standard ratio is a bit different. It has also curled upward, but it is not nearly as low on its chart. Hence, the computer analysis programs are not saying that this is a confirmed sell signal.

Market breadth weakened considerably during the period after $SPX ran into resistance at 4200 on February 2nd. Breadth has been so weak since then that both breadth oscillators reached oversold territory. But there are not confirmed buy signals from breadth yet.

The volatility complex is beginning to weaken. First, $VIX has returned to "spiking" mode, as of Feb 21st. That alone is not a buy signal; it is merely an oversold condition. The broad market ($SPX) can fall sharply while $VIX is in spiking mode. Eventually, though, it will lead to a new "spike peak" buy signal.

We have re-established a "core" bearish position. I see that the bulls are writing this most recent decline off as "normal February weakness." We shall see. That may be true, but when that weakness breaks key support levels and creates a false upside breakout, I think it's more than "normal" weakness. In any case, we will trade confirmed signals from our other indicators around the "core" bearish position.

This Market Commentary is an abbreviated version of the commentary featured in The Option Strategist Newsletter.

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