Weekly Stock Market Commentary 7/17/2020

By Lawrence G. McMillan

The S&P 500 Index ($SPX) continues to trade in a tightening range. It seemed as if the closing of the gap on the island reversal and subsequent move above 3185 should have been enough to push the post-March rally to new highs, but once the Index reached the June highs at 3235, it stalled. It has attempted to break through that area a couple of times now, but has failed. Prior to that, the bears pushed the Index down below 3140 several times, but couldn't get a break-down either. So, for now that is the trading range (roughly, 3115 3235) until one camp or the other can get enough momentum going to engineer a breakout.

If such a breakout does occur, there would be resistance on the upside at the all-time highs, 3390. On the downside there should be support anywhere in the 2920-2970 range (the 200-day moving average at 3030 might also provide some support). Overall, the chart of $SPX remains in a bullish state unless support is broken. A close below 3100 would be a modest break, while a close below 2920 would be a major breakdown.

The "modified Bollinger Band" (mBB) sell signal remains in effect, since $SPX has not stopped it out, which would require a close above the +4å Band. That Band is currently at 3290 and moving slowly higher. Of course, if $SPX rallied towards that area, the Band would move higher as well. This is a bit reminiscent of what happened in January, where $SPX continued to rally for a while after the mBB sell signal. But that signal was not stopped out in February and was therefore still in place when the market took its huge drop.

Equity-only put-call ratios plunged this week, moving to new relative lows and re-instating a major overbought state canceling out recent sell signals. Technically, our computer analysis programs are still rating these as being on sell signals, but that is due more to a "reversion to the mean" process than anything else. In reality, they won't be on sell signals in my opinion until the ratios are visibly rising which they are most certainly not at this time. The standard ratio is down to levels last seen in January 2004. The weighted ratio isn't that low, but is down to where it was in February. The standard ratio is much lower because call buyers are buying low-dollar-cost out-of-the-money calls, which forces the standard ratio lower because of their volume, but the weighted ratio isn't dropping as fast because the dollars being spent on those calls are relatively small. As further evidence of this wild call-buying spree, the CBOE's equity-only put-call ratio has shown daily readings below 0.50 for ten days in a row, including one rare day below 0.40. So, these are in a major overbought state once again, but "overbought does not mean sell."

Market breadth finally improved a little this week, and so recent sell signals for the breadth oscillators were canceled out. Even so, a day or two of negative breadth would easily throw them back onto sell signals. Frankly, the breadth oscillators have moved back and forth between sell signals and buy signals numerous times since the top on June 11th and really aren't giving us much of a clear, tradeable signal at all right now.

New highs have continued to outdistance new lows, although not by wide amounts. This past week, for the first time since February 21st, there were more than 100 new highs on the NYSE, but just for one day. NASDAQ and "stocks only" data sets are a little better, but still not overwhelming. This indicator remains modestly bullish.

Volatility has seen a lot of action again. First, there was a mini-explosion in volatility on July 13th, when $SPX seemed to be about to break out above the highs at 3235, yet instead reversed badly losing 80 points in just a short afternoon of trading. That forced $VIX into "spiking mode" stopping out previous buy signals but by the next day, $VIX had dropped again, thereby establishing the latest in a series of $VIX "spike peak" buy signals. Since $VIX was still relatively high at the time (just below 30), one could play this trade by either buying SPY calls or by buying VXX puts.

Meanwhile, $VIX continues to remain above its 200-day moving average (which is currently at 26.70 and rising). It has bounced off it several times this month. The 20-day moving average of $VIX remains slightly above 30. As long as both $VIX and its 20-day MA are higher than the 200-day MA, that is a potential bearish signal for stocks. Hence, the "caution" flag is still out because of this.

The overall slowed pace of movement since June 16th has had the effect of lowering the 20-day historical volatility of $SPX to 20%, which is the lowest it's been since February. The fact that $VIX is above that level is "normal" (most of the time, that is the case), so nothing unusual should be construed by that.

The construct of volatility derivatives remains rather neutral. That is, we don't have a completely bullish setup, but it's not completely bearish either. The $VIX futures are all trading at premiums to $VIX, which is bullish. But the term structure is sort of odd. Frankly, I think it would be almost completely flat with near-term futures near 27-28, and Jan-Feb 2021 futures near those same levels. However, there is the matter of October 2020 futures, which are quite elevated, so the term structure slopes upward until October, and then back down after that. Of course, the prospect of the election is what is elevating those October futures (along with, perhaps, some expectations of the "usual" market problems in October). In any case, the term structure is not sloping uniformly upwards, so it's not in a bullish state. The term structure of the CBOE Volatility Indices is a bit better, but it too slopes down at the end.

In summary, the market is struggling to piece together a strong directional move either way. There was a wide trading range in April and May. And now there has been another one since mid- June. A breakout of this range would be a tradeable event. Meanwhile, short term signals (mBB sell and $VIX "spike peak" buy) can be taken when they are confirmed.

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