Are The Bulls Back In Charge?

By Lawrence G. McMillan

The stock market’s rally yesterday was beyond strong; it was downright Herculean.  The shorts have been crushed, just a week after they seemed to be in control of things.  But are the bulls on safe ground here, or is the market poised to lurch downward again?  That’s a tough question to answer, but it certainly does seem that things are a bit overdone on the upside and some backing a filling is needed – at a minimum.

The $SPX chart is still negative.  That is, the downtrend line from the September highs is still intact, and there is still a lot of overhead resistance up to 1960 or so.  It would take a close above 1965 to clearly erase the negativity from the $SPX chart, in my opinion.

Other than that, though, the indicators are becoming unanimously bullish.  The short-term buy signals (mBB buy signal; $VIX “spike peak” buy signal, and $VIX crossing under $VXV buy signal) are now being joined by intermediate-term buy signals, particularly in the form of put-call ratio buy signals.  These are powerful combinations, and they probably indicate that the $SPX chart will eventually fall in line.  If it does, we’ll add to long positions, but for now, I want the market to prove it to me.

Both equity-only put-call ratios are on buy signals now.  Since these buys are occurring from very high positions on their charts, they should – in theory – be very strong signals.  The Total put-call ratio has moved slightly lower for two days now, but it’s too early to say it’s going to peak for 10 days.  There are still some relatively small numbers coming off its 21-day moving average, so it’s going to take a few more days to determine if that put-call buy signal is in effect or not.

Market breadth was very strong yesterday, although it was not a “90% up day” (hard to believe).  Both breadth oscillators have now reached overbought territory.  That is not a sell signal, however.  Just as “oversold does not mean buy,” so it follows that “overbought does not mean sell.”  In fact, it is usually a positive sign that the breadth oscillators get (extremely) overbought at the beginning of a new bullish leg in the market.  That is happening now.

Volatility indices got crushed again yesterday. $VIX closed below 18, which is further bullish evidence.  The $VIX spike peak buy signal is still in effect, and the fact that $VIX crossed below $VXV is bullish too.  For the sake of having a gauge of sorts, 18 seems to be a point of interest; below there, $VIX is not an impediment to higher stock prices, but if $VIX climbs back above 18, then it would have a more bearish connotation.

October $VIX futures expired this morning.  All of the remaining futures are now trading at a premium to $VIX, and the term structure slopes upward.  The only remaining negativity in the construct of the $VIX futures or indices is that $VXST is still slightly higher than $VIX.  So, the construct of the volatility derivatives is back to a bullish posture.  It’s hard to believe it reverted back to “bullish” so quickly, after being in such a negative state just a week ago.

In summary, the bulls seem to have everything going their way. We are retaining our long call positions, but are not completely buying into the “up, up, and away” argument until the $SPX chart improves somewhat.

This commentary was taken from this morning's edition of The Daily Strategist newsletter.