VXV – Andrew Thrasher

Weekly Technical Market Outlook 1/27/2014

Posted on January 27, 2014 by Andrew Thrasher, CMT

Last Monday I didn’t write a complete Technical Market Outlook from the lack of price action. This wasn’t the case with last week as we saw the global markets bleed red with domestic markets get lead lower largely by the Transports ($IYT).

In Friday’s report, SentimenTrader noted that when the Transportation Average has closed down 3% or more after hitting a new 52 week high, the data is pretty bearish. Jason goes back to 1900 and there have been eight other instances of this occurring. The median loss one month later has been 4.2% and down 5.2% three months later with the index down a median of 15.3% six months later. Now it doesn’t mean that’s where we are headed but the historical data is definitely leaning bearish for the transport industry. While this is pretty gloomy there are some charts I want to look at that show we may have at least put in a short-term low as traders appear to have shown signs of capitulation.

With that, let’s dig into the important charts for this week…

Equity Trend

This is one of the things I find so interesting about technical analysis. With the panic selling that was taking place on Friday, we ended up closing just a few hairs above our 12 month trend line (green dotted line). Obviously we are now under the 20-day Moving Average (red line) and the 50-day Moving Average (not shown) but until we break the 2013 trend line and begin to see the creation of lower highs and lower lows, the current up trend remains intact.

90% Down Days

It’s often said that when we see 90% of the stocks traded (issues) and 90% of the volume down in a single day that this is a sign of capitulation. While we didn’t see 90% of both volume and issues down on Friday we did see 90% of volume and over 80% of issues lower.

The chart below shows past examples over the last two years where we’ve seen at least 90% of volume and 80% of issues down in a single day. You can see that the market reaction over the following couple of weeks/months has been fairly positive. Now if you were to extend the chart and look at the Financial Crisis in 2008, you’d seen this type of action almost on a daily basis and obviously didn’t lead to higher stock prices. Are we seeing the same type of deterioration in the financial markets as during one of the worst periods in recent history? Few would argue yes. So while it’s possible we see some continued weakness, it does seem, based on this set of data, as well as the 40% move in volatility ($VIX) that nearly every weak hand was folded as traders were quick to head for the exits in fear of losing their precious 2013 gains.

Equity Breadth

The selling on Thursday and Friday didn’t seem to have much impact to the Advance-Decline Line. While the S&P 500 ($SPX) is back to late-December levels, the A-D Line is nowhere near its December levels. The Percent of Stocks Above Their 200-day Moving Average however wasn’t as lucky. This measure of breadth is now back under the falling trend line but still well above the December low. While we saw some negative movement in breadth, it’s by no means signaling a breakdown in the equity market, at least not yet.

Equity Momentum

While the past few weeks had been enough time for the Relative Strength Index (RSI) to catch up with the equity market and slightly break into ‘overbought’ territory, the negative divergence in the MACD held out and helped pull stocks lower last week. The RSI is now testing the lower level of its bullish range, and I’ll be watching to see if buyers are able to step in this week and push momentum, at least the RSI indicator, higher and keep it from getting ‘oversold’ by breaking under 30. We haven’t seen much movement in the Money Flow Index as it’s stayed fairly constant with a slight negative bias.

Volatility

Along the same lines as the charts above, we saw signs of excessive fear in the $VIX curve. Below is a chart of the ratio between the 1-month Volatility Index ($VIX) and the 3-month Volatility Index ($VXV). Typically we see the $VIX trade at a discount (read: less than 1) to $VXV. This is normally due to traders being more fearful of market events further in the future than in the current trading environment. However, when we see large swings in the $VIX that show traders paying higher prices for current protection compared to protection from volatility 3-months away it pushes the ratio shown on the chart above 1 (which is called backwardation). Historically we have normally seen a short-term bottom put in for the equity market on past instances of backwardation in volatility. You can see a few examples of this in the chart below, when the $VIX has entered backwardation the S&P 500 ($SPX) has rallied.

Bonds

Make sure you check out my post from last week where I discussed The Bond Chart I’m Watching Right Now.

S&P 500 60-Minute

The resistance I’ve been watching over these past couple of weeks has held strong as the Relative Strength Index (RSI) began to break down and create a slight negative divergence (lower high while $SPX tested the previous high) on the 60-minute chart. The RSI has now broken below 30 and is ‘oversold’. How long momentum stays ‘oversold’ could give us a clue to how strong the sellers are in keeping equity prices depressed.

Last Week’s Sector Performance

It’s to no surprise that we saw two of the low-beta sectors show relative performance strength (meaning how the sector performed against the S&P 500). Utilities ($XLU) and consumer staples ($XLP), while down on an absolute basis, lead the nine S&P sectors for the week. Materials ($XLB) and industrials ($XLI) were the weakest sectors for last week.

Year-to-Date Sector Performance

While we haven’t had very much data to look at for our YTD performance, I think it’s still important to see which sectors are leading as we get into 2014. Like last year, health care ($XLV) continues to be the strongest sector for this year with utilities ($XLV) coming in a close second. Like in the weekly data discussed above, materials ($XLB) are the laggard for 2014 so far.

Major Events This Week

These are the economic reports I think traders will be watching this week. The bulk of the news coverage will likely be around the FOMC announcement on Wednesday as well as the GDP data on Thursday.

Monday: New Home Sales
Tuesday: Durable Good Orders and Case-Shiller Home Price Index
Wednesday: FOMC Announcement
Thursday: GDP and Jobless Claims
Friday: None

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Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Weekly Technical Market Outlook 12/16/13

Posted on December 16, 2013 by Andrew Thrasher, CMT

Last week we saw the equity market add to its slight loss for the month of December, down nearly 1.65% for the week. Most of the loss came on Wednesday with Thursday and Friday following it up with just a few additional points lost on the S&P 500 ($SPX). With that, let’s get into this week’s Technical Market Outlook….

Equity Trend

Things continue to be positive on the daily chart of the S&P; we have lost the support of the 20-day moving average but continue to stay above the 50-day and the trend line off the 2013 lows.

Equity Breadth

With the weakness in the equity market last week we saw a continued drop in market breadth. The Advance-Decline line tested has moved closer to support but remains in an up trend. JC Parets wrote a great post on his blog, All Star Charts, taking a look at breadth as well as the McCellan Osc.which is a tool used to measure the momentum of the Advance-Decline line. Check it out to get another view of market breadth.

Equity Momentum

The divergences in our three momentum indicators continued to lead the market lower. The Relative Strength Index (RSI) has yet to drop to prior support but recently has been making lower highs and lower lows. While we are still in a bullish range when it comes to momentum, things continue to look weak as buyers struggle to get their footing this month.

S&P 500 60-Minute

Last week I noted that I would be watching the 1810 level as the first potential short-term resistance on the 60-minute chart of the S&P 500 ($SPX). It seems buyers were unable to hold above that level and price headed lower. We did however close up the week with the RSI indicator above the traditional oversold level of 30 which is a positive sign. There’s not much support, but we can watch 1772.5 which is where the most recent shadows of the past few candles have hit. To see the up trend continue the 1782.5 level will need to break as buyers put in a higher high.

Volatility

The Volatility Index doesn’t get much discussion on the blog, but I do try to highlight it when we are near historical extremes. This isn’t the case this week but I still want to show the chart below, which is the ratio between the 1-month Volatility Index ($VIX) and the 3-month Volatility Index ($VXV). We can use this ratio to see where traders are placing their ‘fear’ bets, if you will. When the green histogram is rising we know that 1-month volatility is outpacing 3-month volatility as traders become more fearful of current market losses than 3 months out.

I’m not overly concerned with the relative performance as I am with the number itself. When the ratio gets above 1 the Vix ratio (i.e. its term structure) shifts from contango to backwardation (read more about the two here). As you can see from the chart below, the term structure spends most of its time in contango, with further-dated contracts trading at a premium to front-dated contracts. When things shift to backwardation we know that traders are more fearful of the present than they are of the future. As the chart shows, this often happens near short-term bottoms in the equity market. Right now we are still in contango but the premium for the 3-month Vix has been dropping as the 1-month Vix rises in relative performance.

Last Week’s Sector Performance

Last week’s sector performance was very interesting. As I mentioned in the first paragraph we closed the week in the red, however the sectors you’d expect to show strength aren’t the ones that actually did. The three strongest sectors last week were consumer discretionary (cyclicals), materials, and industrials. With health care being the laggard for the week followed by consumer staples – two defensive sectors. The selling that took place in the major indices was not severe and it did not resemble panic action, which helps explain why we didn’t see a large shift in ‘risk on’ ‘risk off’ sectors, but I’m still surprised where the strength came from last week.

Year-to-Date Sector Performance

With health care apparently taking the brunt of the selling last week we now have consumer discretionary (cyclicals) taking the lead as the strongest relative sector year-to-date.

Commodities

We didn’t discuss commodities last week so I wanted to check back in with this struggling asset class. On a relative basis with the S&P 500, the commodities tracking ETF ($DBC) is positive for December (bottom panel of the chart). There is still much work to be done for commodities to return to an up trend, but it’s taken one step in the right direction on a relative performance basis. Looking at the price action of $DBC things don’t look as good. The RSI indicator hit resistance and turned lower with price unable to hold above its 50-day moving average. It appears commodities put in yet another lower high as the down trend continues.

Major Events This Week

Financial commentary will be packed full of opinions surrounding the FOMC meeting on Wednesday and whether the Fed begins to taper it’s QE stimulus program. I personally don’t think the Fed announces the taper this month, but may provide a little more clarity to their future plans. Here’s what is scheduled to be announced this week that traders may want to keep an eye on:

Monday: Industrial Production
Tuesday: Consumer Price Index
Wednesday: Housing Starts, FOMC announcement
Thursday: Jobless Claims, Existing Home Sales
Friday: GDP

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Strengthening Correlation Between Equities and Volatility

Posted on December 21, 2012 by Andrew Thrasher, CMT

Everyone today will likely be talking about the flash crash in the e-minis and what transpired last night in D.C. I won’t spend much time on that as there are plenty of other bloggers covering it, Josh Brown threw up a great piece last night on the topic.

What I’d like to take a look at is the interesting setup taking place between the front month and 3-month volatility contracts. Right now it seems that traders care more about volatility in the next few weeks than they do a few months down the road. This isn’t likely to shock anyone, with the fiscal cliff looming it makes sense that traders and portfolio managers are buying protection via the front-month $VIX.

I’ll often look at this ratio at market turning points as it can give an idea of how complacent or nervous traders are at market tops and bottoms. However, we aren’t at an extreme reading in the relationship at this point. But what currently makes this setup interesting is the increase in 45-day correlation between the ratio of the $VIX and $VXV to the S&P 500.

The chart above shows the ratio between the front-month ($VIX) and the 3-month ($VXV) volatility, as you can see, it’s been rising since late-November. In the top panel I’ve put the 45-day correlation with the S&P 500. Since 2010 there have only been six other occurrence of the $VIX:$VXV ratio having a positive correlation to equities. So although equities have been enjoying a nice uptrend (until recently), traders have been buying large amounts of front-month volatility contracts in relation to the 3-month volatility.

One last comment on the fiscal cliff. Price action in equities has been revolving around the whispers and press conferences in Washington for the last few months. Congress now goes on vacation (unless President Obama calls them back) until next year. What’s important going forward is what will traders focus on next. Will we get the normal end of the year window dressing or will continued speculation of the cliff still plague the markets?