We first published an in-depth article on this subject at the end of July, 2016. Since that time, the market has mostly gone higher, and no significant top has formed. Since the U.S. election, especially, the market has rallied strongly. Now, having reached an overbought state, some sell signals are beginning to appear. This is a review of current conditions vis-a-vis the four major tops that were discussed in the previous article.
First and foremost, it must be noted that the chart of $SPX is still in an uptrend. The 20-day moving average is rising, and no major trend lines have been broken. $SPX has rallied so hard and so fast since the election that it is quite a ways above support, which is 2210 and 2190. As long as that support holds, the chart of $SPX will arguably still be in an uptrend.
Last July 29th, we wrote an in-depth article on “Spotting Market Tops.” The things that we talked about in that article are beginning to happen. No one has been more “on board” with this post-election rally than we have, as a number of seasonal and oversold conditions combined to produce good buy signals. But now the signs of a top are beginning to appear, and we do not want to be caught unaware. We will publish a blog this week with some specific updates on how what’s happening now fits (or doesn’t fit) the pattern of past tops.
While we’re on the subject of seasonality, let’s review what happened over the past two years, because the seasonality did not remain bullish throughout the “usual” period. The “usual” period is that the market rises from the day before Thanksgiving through the second trading day of the next year. There are really three seasonal patterns that comprise that entire time frame: a) the post-Thanksgiving bullishness, b) the “January effect,” which now takes place in December and has for many years, and c) the “Santa Claus rally.”
The S&P 500 index ($SPX) has tagged its upper “modified Bollinger Bands” (mBB) a couple of times recently, but in neither case was a sell signal triggered. So far, this has been the “correct” move, as $SPX has moved higher. Eventually, though, this sell signal will take place, and one should be prepared to act on it. Figure 5 shows a close-up of the recent action in $SPX.
The bullish juggernaut was finally slowed a bit this week by the Fed's decision to raise interest rates (or at least, that was the excuse for some profit-taking). However, the chart of $SPX remains very strong, and this is a period of highly bullish seasonality.
Put-call ratios are remaining bullish. Both equity-only put-call ratios are declining daily, although the pace of their decline has slowed over the past two days. Even so, a declining put-call ratio is bullish for stocks.
We are proud to announce that McMillan Options Mentor head mentor, Stan Freifeld, will be giving a complimentary presentation tommorrow. The title of the webinar is "Early Exercise: Strengthen Your Position" and will explain the difference between American and European style options plus discuss the theory and practical application of early exercise. Get more information and register for the webinar by clicking here.
Nearly every day, one hears a trader on TV telling you to “buy protection, because it’s cheap.” Is it, really? Yes, $VIX is low, so that means that overall implied volatility of $SPX options is low, and therefore by inference, one might think that $SPX puts are cheap.
It’s more complicated than that. It depends on two things that these commentators never mention – the skew of the $SPX puts, and the term structure of the $SPX puts (or the $VIX futures, if you prefer).
This has been a very strong week for the stock market. New highs have been registered by all the major indices. Not only have all of these major averages traded at new all-time highs, but these moves have been accompanied by strength from the technical indicators. The only problems that are cropping up are those from an overbought market, but as readers know "overbought does not mean sell."
There is support all through the 2170 to 2190 area. As one might expect, call buying has been heavy this week, dominating put volume. Hence the put-call ratios are dropping rapidly. That means that both of the equity-only put-call ratios are on buy signals.
The bulls finally took total control for a day as nearly every major average broke out to an all-time high (the one exception – the NASDAQ Composite – is within a mere 5 points of a an all-time closing high). $SPX advanced so swiftly that it is now above the +4σ “modified Bollinger Band.” As such, a sell signal will definitely occur in the near future, when $SPX closes back below the +3σ Band. Today, that would require $SPX to fall to 2227 – a drop of 14 points. The +3σ Band is moving higher daily, though, so that number will change as the days go by. An mBB sell signal will be a significant negative, but it is not necessarily an immediate sign of the top of the market. The last two mBB sell signals were in November 2014 and October 2015.