McMillan Market Commentary for 6/10

The broad stock market has been under more selling pressure in the last two weeks than in the previous nine months. Intermediate-term indicators are all bearish at the current time, but after five weeks of selling, some oversold conditions have arisen. We’ll review both the intermediate-term and short-term conditions, by indicator.

First, consider the chart of $SPX itself. The bull market trend line extending back to last August was broken and replaced by the current downtrend line on $SPX. That makes the $SPX chart bearish. It had become oversold by the fact that it was 3 standard deviations below its 20-day moving average. That oversold condition indicates a possible rally back to that moving average, currently at 1320.

The equity-only put-call ratios have remained on sell signals since mid-April. They are racing higher now, and by their sheer height might be considered a bit oversold. But they will remain bearish until they roll over and begin to trend downward. The feature article describes the total put-call ratio, which is oversold and is setting up a major buy signal. However, as long as the market trends lower, it is possible that the total put-call ratio will continue to increase, thereby deferring the buy signal.

Breadth has been very negative. Both breadth oscillators have been on sell signals for some time, although the NYSE-based one has flirted with buy signals in the last week. That eventually resulted in major oversold indicators from both breadth oscillators. Today’s rally in the market will likely alleviate these oversold conditions to some extent.

The volatility indices ($VIX and $VXO) spiked up to nearly 20 last Friday, when the market sold off sharply on bad
unemployment numbers. $VIX then proceeded to reverse downward sharply, nearly getting back to 17 that day. A spike peak reversal of that magnitude is normally a buy signal for the market, but there was no response from $SPX all week, until today. Meanwhile, in the interim, $VIX started to climb again and closed at its highest level since March. At this point, a close above 19 would signal further trouble ahead for the market since it would solidify an uptrend for $VIX. In contrast, a close below 17 would put $VIX in a much more bullish status. Other volatility measures that we follow are negative. The 20-day historical volatility of $SPX has risen to 15%, from readings below 10%, and that is a sell signal. Also, the Composite Implied Volatility (CIV) of all equity options had risen to the 25th percentile (currently 19th) from a low of 6th a month ago. That, too, is a sell signal.

The premiums on the $VIX futures have remained fairly large. Only the near-term June futures have traded at a discount, and they expire next Wednesday. At a strong, intermediate-term bottom (as we saw in March), all of the $VIX futures would be trading at a discount. Thus, their penchant to retain premium now is actually a bit bearish, because it is reflecting a continued bullish complacency. The same can be said of the term structure, which continues to slope sharply upward.

In summary, the intermediate-term indicators are negative (with the possible exception of $VIX). The oversold conditions may propel a rally towards 1325, but as long as $SPX is trending downward, the bears are in charge.

Larry McMillan