Is the Bearish Genie Out of the Bottle?

By Lawrence G. McMillan

A violent rebound occurred yesterday, signaling that either a) Friday’s move was an aberration, or b) volatility has returned with a vengeance.  Today, S&P futures are down 17 points in overnight trading, for no specific reason.  There has just been a continual erosion all night long.  That would argue for b) above.  We are now getting mixed signals from some reliable indicators.  These will sort themselves out, but for now there is some conflict.

Let’s start with $SPX.  The rally yesterday did not change anything, as it merely was a rebound towards resistance.  The breakdown from Friday turned the charge to neutral, at best, and to bearish by some ways of thinking.  Clearly a break of the support at 2120 (yesterday’s low and the old highs from last year) would be a definitive bearish statement.  But, in between, one can make the argument for a lower trading range: 2120-2160, for now.

The increase in realized volatility has been large, with the two big moves in the past two days.  Hence, the “modified Bollinger Bands” (mBB) have exploded away from the 20-day moving average.  A buy signal could set up if $SPX closed below the –4σ Band (currently at 2118 and falling), while a sell signal would need to see $SPX rise above the +4σ Band (currently at 2240 and rising).  The latter seems highly unlikely at this time, and even the former (the buy signal) is probably not a high probability either.

The equity-only put-call ratios have been steadfast in their sell signals, and they remain on those sell signals.  Moreover, they are still very low on their charts, meaning that they could have a long way to rise before buy signals occur.  This remains our most bearish indicator.

Market breath was strongly positive yesterday, although it was not a 90% up day (due mostly to some early selling which put just enough issues into negative territory so that the later rally could not reverse them completely).  Both breadth oscillators thus still remain on sell signals.  Today appears to be a day that will start out with steeply negative breadth, so these indicators are likely to remain on sell signals.

Volatility is the only area where there is some bullishness. $VIX generated a spike peak buy signal, and there was also a “$VXST crossover” buy signal.   Even the trend of $VIX is in question.  Was the breakout Friday enough to create an uptrend (bearish for stocks) or did the huge reversal downward by $VIX yesterday negate that?  Hard to say, but with the $VIX spike peak buy signal in place, $VIX is now a positive indicator unless it violates yesterday’s high – which is all the way up at 20.51, due to negative overnight trading on Sunday night. $VIX prices begin reporting at 3:30 am each morning, and so that high of 20.51 was registered before the NYSE opening.  A year or so ago (when $VIX only priced during NYSE hours), the $VIX high would have been about 18.10, so the “spike peak” buy signal wouldn’t have even occurred!  This is a common problem with indicators that have track records based on one set of trading hours: things can change when you include overnight movements.  One might even say that the stop for the current signal should be 18.10, not 20.51, which is a big difference.  I’ll have to mull that some more, but for now we’re sticking with the “classical” stop for the $VIX signal.

In summary, yesterday’s rebound was a welcome relief for the bulls.  But it looks like the bearish genie (or at least the volatility genie) may be out of the bottle, as today’s action is highly negative.  For now, it seems that volatile moves within the 2120-2160 range are the new norm, and a breakout in either direction would better determine the intermediate-term direction.

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