Yesterday was not a good day for stocks, but considering how far the rally has come in the last few months, it wasn’t too surprising to see a setback of sorts. However, the selling generated some sell signals and it has left a warning sign on the $SPX chart – an island reversal. One does not often see islands on the averages because the electronic computation of the Index begins as soon as any stock in the index opens. If there is a gap on the $SPX chart, it essentially means that nearly all of the stocks are opening on gaps. In any case, an island reversal of this sort is a big negative.
As a general rule, I am not in favor of shorting the market when $VIX is “too low.” That is usually a loser’s game, as the market doesn’t turn downward until $VIX begins to trend upward. However, there is a combination of factors that we researched a long time ago (at least 10 years) that is now coming up again.
$VIX was invented by Professor Whaley for the CBOE and first published in 1993. That version of $VIX used only 4 series of $OEX options. It used the two front month options, and the two nearest strikes that surrounded $OEX’s price. It was backdated to 1986 so that the Crash of ‘87 could be in the data.
The broad stock market, as measured by several indices, but particularly by the S&P 500 Index ($SPX) has broken out to new all-time highs. Other indices that have done the same include the Dow ($DJX), NASDAQ Composite, NASDAQ 100 ($NDX), Midcap 400 ($MID), and the NYSE Index.
This breakout has reaffirmed the bullishness of the $SPX chart, as that had come under some doubt with $SPX mired in the 2255-2280 trading range. Now the 2280 area is support, as is the 2255 area. Below that, there is major support at 2233 (the December lows).
This system has been successful over the years. It is a short-term trade, wherein we buy “the market” at the close of the 18th trading day of January. The position is sold four trading days later. The basis for this system is that institutions usually receive large cash infusions in (early) January. They employ this new capital somewhat judiciously during the month, but by the end of the month they want to be fully invested so that a large cash balance is not showing on their month-end reports. Hence they buy at the end of January.
The broad stock market, as measured by $SPX, has traded in a very narrow range since early December (with one very brief excursion below the range in late December). That range is essentially 2250 to 2280, an amazingly small range for a 5-week period of time. As a result, realized volatility has declined to very low levels.
Looking at the more traditional support levels, the first is at 2233 (the late-December lows), with support at 2210 and 2190 below that. As long as $SPX remains above that 2233 support level, we cannot turn bearish, despite what the other indicators might be saying.
After all the positive seasonality that surrounds the end of a year (Post-Thanksgiving rally, Santa Claus rally, January Effect), it is probably not too surprising to learn that there is a system that relies on a bearish seasonal pattern. That is, after about 8 to 12 trading days into a new year, the stock market – particularly, the NASDAQ market – tops out and trades lower for a week or so. This year, with NASDAQ being so strong, one wonders whether the system will work. But there have been times in the past where the system has worked even when NASDAQ was relatively strong in comparison to SPX. The system is sometimes known as “The January Defect.”
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The stock market has split into two parts recently. Most of the major averages are moving sideways, but staying within easy range of new all-time highs. The NASDAQ Composite, however, and its smaller companion the NASDAQ-100 ($NDX) have been making new all-time highs frequently. This should be a good thing.
The $SPX chart remains bullish in that its trend lines are sloping upwards and support has held. There is support at 2233, and then at 2210 and 2190 below that.
A bearish development has taken place in the equity-only put- call ratios, as both have rolled over to confirmed sell signals. Market breadth continues to bounce back and forth.
There was finally a little volatility yesterday, as President-elect Trump’s news conference halted a rally dead in its tracks. There were two resulting selloffs, but by the end of the day, $SPX had recovered and closed on its highs. It now once again stands less than two points from new all-time highs. Meanwhile, the NASDAQ Composite and its smaller companion $NDX made new all-time highs once again. Since the election, the NASDAQ Composite has made new all-time highs on 13 different days – including the last five days in a row! This is clearly where the market’s strength is at this time. Overnight, $SPX futures have been on the defensive all night and are now down about 9 points from yesterday’s close.
The media confuses the various seasonal trading patterns that occur in January, but the January Barometer states that “As goes January, so goes the year.” This adage is about to be tested again this year.
The January Barometer had a long, successful track record for many years (using the $SPX index as “the market”). According to the Stock Trader’s Almanac (www.stocktradersalmanac.com), the Barometer – which was devised by Yale Hirsch in 1972 – has had only 8 “significant” errors in 66 years. The Catch 22 here might be the word “significant.”
From my point of view, it has failed for the last three years...