Looking at the VIX

As you may have noticed, the VIX futures market has moved into "backwardation" during the course of the market's recent sell-off.  Backwardation occurs when near-term VIX futures become more expensive than longer-term VIX futures (in this case the 3 month VIX contracts).  This is a fairly rare event and suggests that traders are betting that volatility in the future (3 months out) will be lower than it is now.

Since 2012, when this situation has occurred it has been a rather reliable indicator to buy the market. This makes sense because, as we've frequently mentioned, the market has ended nearly every pullback with a sudden V-bottom over this timeframe.  In fact, in the chart below you'll see that if you were to employ such a strategy since 2012, you enjoyed really consistent, positive returns over the near and intermediate term.  Note: VXV represents 3-month volatility.

However, we've expressed some concern in recent days that this pullback/correction appears to be reminiscent of the more prolonged pullbacks that we saw from 2009-2011 and today's plunge further reinforces that belief.  So with that in mind, we ran the same backwardation study as above for 2009-2011. You'll see that the S&P's returns over the first 5, 10 and 20 days came in far more muted than the 2012 to early 2015 market.  However, returns for the index after 50 days were higher.

Since today's action makes the potential for a V-bottom less likely, it looks as if we could be in for a choppier path that more resembles the data in the 2nd chart shown.  Something to consider over the next couple of months.

Week In Review (8/24/15 - 8/28/15)

After starting off on a pretty gruesome note, US stocks recovered enough to finish the week in positive territory.  Yet if you had polled the average investor after Monday's carnage or Tuesday's stunning downside reversal, we'd bet that most were on the verge of throwing in the towel.  At its lowest, the S&P 500 was -5.2% below the previous Friday's close and -12.5% below its all time high set back in May.  In fact, all of the major domestic stock indexes entered "correction" territory over the last week.  Classically defined as a 10% pullback from prior highs, a correction phase had hit the Dow, S&P, Nasdaq and Russell 2000.

For all the hysteria that Monday and Tuesday caused, Wednesday and Thursday swung in the opposite direction as the Dow recorded its largest two-day point gain ever.  By Friday's close, the indexes were up modestly for the week as if (on the surface) nothing had ever happened.

However, with Monday being the last day of the month, stocks look poised to finish August with rather significant losses.  Each of the major indexes are still down more than 5% for the month and all but the Nasdaq are in negative territory for the year.

While the indexes did put up a valiant effort this week, there are some concerning developments from a technical perspective.  Of greatest concern perhaps is that the monthly chart of the S&P looks as if it will close below its 12-month moving average.  This has historically been a decent warning indicator for signaling the potential for more downside ahead.  This is something we're going to be watching closely in the months ahead to see how the index responds near and around this moving average.

Also, on the daily chart, you've got the 50-day moving average on the verge crossing below the 200-day.  This is something that hasn't happened since 2011.

One positive technical development to note are the very bullish candles the indexes formed on the weekly charts.  After plunging to such lows early in the week, markets fought back to close at the very high end of their weekly range to form what's called a "hammer" candle.

There were also a number of capitulation signs flashing on Monday and near Tuesday's close.  Monday registered as a 90% downside day both in terms of volume and points traded and Tuesday's last hour of trading carried with it some signs of panic selling.  By Tuesday's close, we were seeing some seriously oversold measures and felt that a rally (likely short-term in nature) was due.

As we suggested in Tuesday's post, we would be surprised if the market were to put in another V-bottom like it did last October.  Historical precedent just doesn't support that type of action.  The market is likely to complete this current mini-rally and then undergo some type of retesting action where clear lines of defense are formed by buyers and sellers.  Volatility is likely to remain at least slightly elevated through this process until one side overpowers the other.  We're not as eager as others to attach a specific headline(s) to market's recent moves but whatever the cause might be (China economy slowing and currency devaluation, Federal Reserve rate timing, oil and commodity volatility, etc), we know that we've entered a new phase of this bull market and we're putting extra emphasis on capital preservation as things work themselves out.

Lastly, as one could probably guess, there haven't been many places to hide on the sector level during the course of the month.  Utilities have bucked their recent trend and been an area of strength during the most recent bout of volatility.

Week In Review (7/27 - 7/31)

Stocks enjoyed a small bounce this week and repaired some of the damage done in the 7/20 - 7/24 trading week.  The S&P 500 was up 1.2% and served as a leader among the major domestic equity indexes.

The last day of the trading week was also the last day of the month and July turned out to be fairly rewarding for most US markets.  The Nasdaq once again served as the pace car with a 2.8% gain.  The S&P also logged a strong month, rising nearly 2%.  However, small cap stocks showed some unfortunate divergence as the Russell 2000 fell 1.2% over the last 30 days.

In terms of news, we saw Q2 GDP come in slightly below expectations while the Q1 number was revised higher.  In parsing the Federal Reserve's comments this week, the market still appears unconvinced that Chair Yellen & Co are soon to act on raising rates.  While the most recent language did note the improving labor market conditions, other data was not as promising.  We'll surely find out more in coming weeks.

Energy stocks continue to be the red headed step child of this market as it was another terrible month for crude oil and related companies.  For July, crude was down 21% and fell more than 2% on Friday alone.

Last week we highlighted the lack of upside participation by various sectors in this market and still believe this will be an important factor to monitor in the final 5 months of the year.  While its great to see the strong moves in health care and cyclicals, we'd like some other areas of the market to step up and provide some support.  If either of these two leaders were to stumble, it would be tough for stocks to finally break out of this sideways range to the upside.

After again testing its 200-day moving average on Monday, the S&P 500 bounced hard and sits comfortably back above the 200 and 50 day, for now.  Our Thursday post examined the concerning look of the Dow Industrials chart.  The XLI (Select Sector SPDR Industrials ETF) is showing some signs of damage that investors would be wise to acknowledge.  The index's 50-day moving average has crossed below its 200-day (a sign of weakness) and it recently failed to break back above what had served as prior support.

While the index did enjoy a bit of a bounce this week, it's no where near out of the woods.

Lastly, we leave you with a year-to-date view of where things stand for US equity markets:

Have a great weekend!

A Technical Look At The Dow

Barron's was out this week with an interesting take on the Dow Jones Industrial Average and its recent encounters with several key technical levels.  

In the magazine's "Getting Technical" section, columnist Michael Kahn notes that, among other things, the: 

"Select Sector SPDR Industrials exchange-traded fund ( XLI ) is in serious retreat. And that does not bode well for the market and arguably for the economy a few months down the road.  

Though dominated by General Electric ( GE ) with its 10.2% weighting in the ETF, XLI still gives a good representation of what is happening to the sector. Peaking in February, the ETF has lost roughly 9% through Monday’s trading (see Chart 1). And this month, it joined utilities, energy and basic materials as the only ones with moving average death crosses in place. Each has its 50-day average below its 200-day average and that is not a healthy condition."

He goes on to note that the index failed to breakthrough prior support during the most recent rally in equities and has fallen below its long term trendline that dates back to August 2011.  He adds:

"But what I find more interesting is that the last time the market suffered a significant correction, aside from last year’s Ebola-inspired mini-panic, the industrials broke down first. That was in the summer of 2011 and the industrial sector broke down about a week before the broad market did (see Getting Technical, “Industrial Stocks Are Shutting Down,” August 1, 2011). Although we cannot make a rule out of so few observations, it probably is a good idea to keep cash levels higher than normal.

From the long-term view, the industrial ETF is now approaching a Fibonacci 61.8% retracement of its October 2014-February 2015 rally. It has already dipped below the major trendline drawn from the end of the 2011 correction although given the elapsed time and price movement involved I do not think this was a breakdown - yet.

Should the sector keep falling, the breakdown would be undeniable and a move back to the October 2014 low would be in cards. That would be a drop of roughly 7% from current levels."

We found this article to be an interesting take on the current environment and definitely something that bears watching.  With industrials being the canary in the coal mine before the 2011 broad market breakdown, they may deserve extra attention in this scenario.

Current Take

It's been 12 full trading days since the VIX poked itself above the much watched 20 level.  As we noted earlier in the month, buying the S&P 500 when the volatility index had risen above this level has provided steady opportunity for gains over the span of this bull market.  To review, since 2012, if you had bought the S&P each time the VIX clipped the 20-level you were likely to have achieved solid gains looking 5 to 50 days out.

According to the study above, the S&P has returned, on average, nearly 3.75% in the 10 days following a breach of the 20 level.  Last Thursday (7/23) was day 10 in this instance and at the time we were at least in spitting distance of staying on trend.  As of the close on Thursday, the S&P had risen 2.5% from its close on July 9th at 2,051.  At its high point on July 13th, the index got up to 2,116 which is a 3.1% gain.  However, in the two trading days since, the S&P has fallen swiftly and closed yesterday just 0.8% higher (2,067) than its 2,051 starting point.  Clearly, if the market intends to stay somewhat on trend with recent history it has its work cut out for it over the next 8 trading days.  The S&P has averaged a 20-day gain of 5.4% since 2012 when the VIX has traded above 20.  This would equate to an S&P close of 2,161 which is 85 points higher than where we're trading at this very moment.

One culprit in the S&P's inability to generate a sustained bounce is likely the lack of breadth and participation.  We've written on this topic many times before and you've likely seen renewed talk of it elsewhere in recent weeks.  Fewer and fewer sectors and stocks have been responsible for the market's recent thrusts higher.  As Andrew Adams of Raymond James summarizes:

The two graphics above illustrate an important point.  While the market has continued to move somewhat higher (ever so slightly) over the course of the year, it's done so with less leadership.  And while that can be fine for a time eventually one of two things happen:  the leaders stumble and take the market with them or the laggards play catch up.

It's now been nearly 4 years since the market's last 10% correction, much longer than the historical average and something that should not be ignored.  However, even with the recent weakness the S&P sits less than 3% from all-time highs.  Bears are going to need some additional catalysts in order to push this resilient market lower.

Looking more broadly at various levels, we'll be watching to see how the index handles any of the following:  a revisit to the 200-day moving average (currently at 2,065), the 2,040 - 2,050 zone which is the area of the most recent lows and the March lows, and lastly the 1,970 - 1,990 zone which would be going back to the December - January lows.  

We also believe that watching the monthly chart and its 12-month moving average continues to be a major tool.  A close below this indicator would likely introduce further weakness while staying above at the end of July could serve as the basis for a trip back up to the top end of the range.

Week In Review (7/20 - 7/24)

Stocks struggled this week as the S&P 500 was down 4 out of 5 days and finished -2.21% lower from last Friday's close.  Meanwhile, the Dow Jones Industrial Average suffered its largest 1-week drop since December.  Friday was the ugliest day of the week as Biotech stocks like Biogen were hit hard. Biogen was down 22% for the day after issuing disappointed guidance in its quarterly earnings release.  The Nasdaq Biotechnology index was down more than 4% for the week.  This was more than enough to offset the market's glee over Amazon's earnings.  The stock opened trading Friday 20% above Thursday's closing price.  However, those gains were halved during the trading day as the weight of the market pulled it back into the atmosphere and it finished "only" 9% higher.

As the Wall Street Journal noted today, the market has, in recent weeks, seemed to pay less attention to macro events which has allowed investors to focus more on company specific news:

"The focus on individual companies marked a turnaround from earlier this month, when all eyes were on developments in Greece’s bailout talks and China’s tumbling stock

On Friday, dour economic news from China helped accelerate a gathering commodities-market rout, but investors said the big factors driving stocks were earnings-related, perhaps to a fault.

“The market has taken a break from the macro[economic] and is focusing more on the company level,” said Tom Digenan, head of U.S. equities at UBS Global Asset Management. “If you have a bad quarter, that doesn’t necessarily project that things will be all bad going forward, but the market seems to be playing that.”"

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This week's stumble for the stock markets knocked off some of the shine on what was shaping up to be a really strong month.  The S&P is now up just 0.8% for July after being up 3% as of last Friday.  Thanks to some very positive earnings reports by tech giants like Netflix, Google and Amazon, the Nasdaq is still higher by 2% for the month.

Sector-wise it was another tough week for Energy as the space was down another 2%.  Cyclicals, Consumer Staples and Financials held up rather well in the face of the selling in the broad indexes.

AAPL and The Market

Our Tuesday post highlighted the noticeably thin leadership in the market and the need for greater participation if the indexes were to head higher in the 2nd half of the year.  Through the 1st six and a half months of 2015, the market's stalwart has been the health care sector.  It has accounted for half of the S&P 500's overall gain so far and helped to offset the weakness in utilities, energy and elsewhere. In the post, we offered up some recent commentary for Nicholas Colas, chief market strategist for Convergex, where he noted that in addition to health care the sectors looking most primed for further upside were financials and technology.

Mr. Colas pointed out that technology stocks, which make up 20% of the S&P, had shown incredible strength in recent weeks including last week where the sector was up 4% after strong earnings reports from Google and Netflix.  Tech certainly has momentum and relative strength on its side right now.  However, those positive feelings were cast into some doubt on Tuesday afternoon when the market decided that Apple's near $11 billion in profits in Q2 were not enough.  The stock was off more than 7% in the after-market and threatening to breach its 200-day moving average in the $119-120 area.

Apple opened trading yesterday down more than 6% at $122/share but managed to rally intraday to close above $125 and down just over 4% for the day.  If there's one stock that could topple the market's upward trend, it's probably Apple.  In terms of size, it makes up nearly 5% of the Dow, 4% of the S&P 500, 15% of the Nasdaq 100 and 18% of the XLK (SPDR Technology Select Sector ETF).  As the Wall Street Journal noted during trading yesterday, the market was being held down by Apple's fall:

"In the price-weighted Dow, Apple, at $124 or so, doesn’t have the biggest weighting; that goes to Goldman Sachs Group Inc. and its $212 stock. However, Apple loss on the day, more than $6 right now, is the largest loss, so it’s having the biggest drag on the index. With the stock down $6.60, it works out to about 44 of the Dow’s current 67-point loss.

It’s easier in the S&P and Nasdaq, both market-cap weighted indexes. There Apple is the biggest component, and with the S&P having such little momentum in early trading, Apple’s is single-handedly pulling the index into the red.

“At $124.49, Apple is taking the index down 0.19% or 4.08 points,” said Howard Silverblatt, the senior index analyst at S&P Dow Jones Indices. “It is taking the S&P 500 Information technology sector down 0.95%.”" 

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Further, the Nasdaq 100 fell more than 1% yesterday and the XLK was down 1.5% primarily because of Apple's weakness.  While the stock's intraday action yesterday was encouraging, we'll want to watch how it behaves in the coming weeks.  Its chart is now showing a triple top ($133-134 area) formation that began back in March.

  

How it resolves itself in this $120-134 zone will not only be important to Apple shareholders but to the overall market as well.  It will tougher for the broad indexes to make meaningful gains if this key component isn't along for the ride.  But with a very reasonable valuation we think the downside will be limited.  It may not take off to the upside like other stocks have upon their earnings announcements but if it holds here we think there's plenty of strength in other areas to propel the market higher.