Market Outlook- Buy On A VIX Drop Bernie Schaeffer, Option Advisor 11.05.07, 11:00 AM ET
Cincinnati, Ohio - October tip-toed out like a lamb, but November roared in like a full-on bear, with a Thursday-afternoon plunge precipitated by renewed credit-market concerns, disappointing Exxon Mobil earnings, crude oil's proximity to the $100 mark, and fears that future rate cuts may be out of the equation for a while.
A muted finish on Friday didn't do much to set the indices on a path to recovery; the Dow Jones industrial average closed down 1.5% for the week, the S&P 500 was off 1.7% and the Nasdaq Composite actually managed a weekly gain, edging 0.2% higher. However, it should be noted that the S&P finished October with a 1.0% gain, once again defying widely advertised crash fears.
But while the major indices hit some turbulent times, they held above some significant levels of support, both from a round number and a moving-average perspective. And a bounce from these support zones would be consistent with the market's behavior in recent months.
Going down the line, the Dow held above 13,500, the S&P 100 Index finished north of the round-number 700 mark, and the S&P 500 closed above 1,500. What's more, the 1,490-level has proved to be remarkable support during the past couple of weeks when observing this index on an intraday basis.
This comes as little surprise, as longer-term support, as defined by the index's 10-month moving average, is situated in this area. The SPX has not experienced a monthly close below this trend line since September 2004. Finally, S&P Depositary Receipts moved forward off support from their 80-day and 160-day moving averages.
Of course, it's never smooth sailing after market turbulence such as we've seen recently, and the current backdrop is no exception. The Dow still has 14,000 to retake, and the historically resistant 2,800-level is staring down at the Nasdaq Composite. And it is 800-watch time yet again for the Russell 2000 Index; the small-cap collective closed mere points south of this century level in Friday's trading.
As I've pointed out in this space more than once, the 2007 stock market has been wrought with caution, bearish hedging activity and pessimism, despite the fact that the major market indexes have remained in positive territory for the year. This makes the entire expectational landscape notably different from some tenuous bull markets of the past, when complacency, contentment or even euphoria ruled the roost. This past week's action, with the Fed decision and the subsequent market pullback, verified that a wall of worry is still very present in this market, which is reinforced by some oversold technical readings that are normally associated with serious bear markets, as opposed to bull market pullbacks.
In Thursday's trading, the Desmond 90/90 Indicator showed up, indicative of a panic in the trading crowd. This reading simply means that 90% of volume and 90% of price action is negative. While not easy to stomach on a day where this transpires, a negative skew of this magnitude can mark a market turning point, as recent data from our Quantitative Analysis group show.
Another indicator we follow that reached a bearish extreme is the Traders Index--also called the Arms Index--which registered a 2.99 reading on Thursday. This indicator measures the relative volume on declining vs. advancing stocks, and readings well in excess of 1.00 as registered on Thursday imply extreme oversold conditions.
Finally, Thursday saw odd-lot short selling (short positions of fewer than 100 shares per transaction) move to its highest daily reading since Aug. 16, 2007. As you probably remember, that day proved to be a short-term market bottom as a panicked urge to sell off anything and everything corrected itself with a renewed buying trend.
And it's not just small-time traders with trepidations toward the market. The latest Barron's Big Money poll, just published this weekend, shows there has been a drop in bullishness among professional investors. In fact, 47% of those responding to the financial weekly's survey say they are bullish about the outlook for stocks through the middle of 2008. This is well below the 64% "bullish" reading from last fall's poll. Furthermore, a hedge fund manager survey from Greenwich Alternative Investments revealed that 50% of respondents were bearish as we moved into November. Over the past couple of years, such elevated levels of bearishness from this group have preceded strong market action.
This cautious sentiment, the propensity for the market to quickly reach oversold levels, bullish fourth-quarter seasonality and the bullish implications of the third year of a presidential term all have me feeling sanguine about a bullish trend perpetuating through the end of the year.
While there have certainly been some major blow-ups as financial engineering met financial reality for mega-cap names such as Merrill Lynch and Citigroup, pure consumer financial play MasterCard posted blow-out earnings, and the stock proceeded to soar. And the "meat and potatoes" economic news is far from grim.
This is not to dismiss the problems at Merrill and Citi, but I must also point out the potential that the Fed will continue to be under pressure to reduce rates to help keep these "too big to fail" giants afloat, which would be bullish for both the economy (particularly housing) and for stocks.
Of course, there are still some areas of market sentiment that aren't ideal. Options-purchase data, as reported by the International Securities Exchange, is not showing much fear. Even while the market was plunging, calls purchased (to open) outnumber puts purchased (to open) at a ratio of 1.71 on Thursday--I'd much rather see readings closer to 100. I will point out, though, that these various option-volume ratios have been getting quite a bit of play from the bears lately, which I see as diminishing their contrarian value.
I'd like to see the CBOE Market Volatility Index (VIX) settle down a bit as well. Currently, it is still above the critical 20 level and atop its 32-week moving average. With the VIX at its current levels, the odds of additional volatility are heightened, creating an additional risk factor for the short term.
http://www.forbes.com/2007/11/05/merrill-citi-volatility-pf-ii-in_bs_1105outlook_inl_print.html This week, earnings season continues to chug toward the light at the end of the tunnel, and economic data are fairly sparse. Additionally, I'd imagine that Fed officials would be fairly quiet in the wake of last week's rate-cut announcement. So we may have a week without too much drama, unless crude decides to show off with a spike above $100 or there are more surprises on the credit front--but keep in mind the Fed will be lurking in the background should the mega-financial players begin to stumble too precipitously.
Bernie Schaeffer is CEO of Schaeffer Investment Research and editor of Options Advisor. Click here for more ideas and recommendations from Schaeffer analysts, and to learn more about Bernie Schaeffer's Option Advisor.
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SPX 20 month "bull market moving average" approximated by generating an 86 week SMA (#msg-22518650 << obliterated post -- replaced with >> ) #msg-22512335
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