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Do Bulls Have the Upper Hand?

What does a low VIX mean for the market going forward?

by 5/24/2014 9:31:19 AM
Stocks quoted in this article:

The Federal Open Market Committee (FOMC) meeting minutes got the bullish ball rolling on Wednesday, as traders cheered dovish comments from the policymakers, and relatively encouraging economic data added to the upbeat mood as the long weekend neared. As such, the S&P 500 Index (SPX) ended at a record closing high on Friday, and the Dow Jones Industrial Average (DJI) pulled itself into positive territory for 2014. As Todd Salamone notes, although the major market indexes are still facing familiar resistance, the sentiment backdrop is favoring the bulls. Meanwhile, Rocky White weighs in on the CBOE Volatility Index's (VIX) recent low, and what that could mean for stocks in the near term.

  • 3 points to ponder on the Wilshire 5000 Index (W5000)
  • The "bullish formation" developing in the Russell 2000 Index (RUT)
  • Are we in for a low volatility churn in the near term?

Finally, we close with a preview of the major economic and earnings events for the week ahead, plus our featured sector.

Notes from the Trading Desk: Round-Number Areas Remain Critical Components of Recent Action
By Todd Salamone, Senior VP of Research

"Global money managers raised cash holdings to a two-year high this month and say America is the worst place to invest, a Bank of America Corp. survey published last week shows. Investors have pulled about $10 billion from funds that buy U.S. equity this month, set for the biggest outflows since August, according to data compiled by Bloomberg and the Investment Company Institute."

-Bloomberg, May 19, 2014

"Quite a few investors have reasoned that a low VIX must mean too much complacency and therefore signal excellent opportunities for shorting equities or initiating positions that would benefit from increasing volatility ... As I see it, the current penchant for being fearful of too much complacency is misplaced. Historically, equities have performed well in low-volatility environments. Trying to anticipate the next big VIX spike based on the amount of time that has passed since the last spike has been an expensive undertaking. In other words, those seeking to profit from low volatility may be better served by simply buying stocks."

-Bill Luby, guest columnist at Barron's (subscription required), May 22, 2014
"$VIX call volume HUGE today, more than 600k contracts- replacing expired May options after $VIX settlement? Coincidental negative for $SPY"

"$VIX settlement price 12.27... 14k calls finish in the money of the 3.43 million calls that expired. $VRO"

"$RUT/$MID support at 1,100 & YTD B/E 1,342 earlier in week; now: $DJIA testing YTD B/E resistance, Wilshire 5000 20k resistance $SPX 1,900"

-@ToddSalamone on Twitter, May 21-23, 2014

Unfortunately, for bulls and bears alike, the persistent range action that we cautioned you about several weeks ago and have observed for a long time showed no signs of abating last week. In other words, multiple benchmarks continue to respect round-number century and millennium marks as support/resistance, while others find support or resistance at year-to-date round breakeven levels.

This past Wednesday, for example, as May CBOE Market Volatility Index (VIX - 11.36) calls expired, there was a stampede to replace expired call options ahead of the release of minutes from the Federal Open Market Committee's (FOMC) latest meeting. Our view is that sellers of the calls likely shorted equity futures, generating coincidental downside action in equities late Wednesday morning. However, as the VIX call activity decreased, equities rebounded, with the S&P 400 MidCap Index (MID - 1,369.66) and PowerShares QQQ Trust (QQQ - 89.88) finding support around their respective year-to-date breakeven marks of 1,342.53 and 87.96, respectively.

Meanwhile, the Russell 2000 Index (RUT - 1,126.19) survived yet another flirtation with its round-number 1,100 mark, briefly dipping below it -- only to close back above 1,100 by day's end. Moreover, the intraday low on the RUT was roughly 10% below its 2014 closing high, an area that offered support the previous week as well. This emphasizes the short-term importance of price levels that reflect round-number percentage gains and losses over certain periods or from extreme levels.

Support for RUT at round-number 1,100 and 10% below high
RUT 30-minute chart since April 2014
Chart courtesy of

With the RUT and the MID around support levels coming into last week's trading, this coming week is set up differently, as a separate group of benchmarks enter the last trading week of May around resistance areas -- namely, the S&P 500 Index (SPX - 1,900.53), which will contend (again) with the round-number 1,900 level. Moreover, the Dow Jones Industrial Average (DJIA - 16,606.27) is again trading in the vicinity of its 2013 close of 16,576.66 -- a level that it has been unable to overcome for any length of time. Finally, note that the Wilshire 5000 (W5000 - 20,123.50) is back above the 20,000 millennium mark. Since its first-ever touch of this mark in late February, the index has become very unstable following advances above this level. Generally speaking, the W5000 has experienced sideways action since late February. In fact, in the 60 days since the W5000 first touched 20,000 on Feb. 28:

  1. On 24 of those 60 days, 20,000 has been touched.

  2. It has closed above 20,000 on 18 days.

  3. It has closed below 20,000 on 42 days.

But, as you can see on the chart below, the 120-day moving average has provided support on pullbacks since late 2012. Therefore, bulls can keep their hopes alive that the probability of a lasting breakout above 20,000 increases -- as long as the index remains above this trendline if a near-term pullback is again in the cards.

Support for W5000 at 120-day moving average; instability above the 20,000 millennium mark
W5000 daily chart since January 2014 with 120-day moving average
Chart courtesy of

From a contrarian perspective, the sentiment backdrop favors the bulls. In the context of the SPX trading around all-time highs and pullbacks in the RUT and Nasdaq Composite (COMP - 4,185.81) holding at support levels, we find it interesting that global money managers are on the defensive, raising cash to the highest levels in two years, in addition to viewing America as the worst place to invest.

Plus, there appears to be caution among many technicians, who have a laundry list of concerns. These include: a RUT and SPX divergence, seasonality, low volume, a low VIX, weakening 52-week highs, and the potential for a bearish "head-and-shoulder" formation, even as a bullish inverse "head-and-shoulder" pattern is a distinct possibility on a short-term RUT chart. Such pervasive caution among this group lessens the likelihood of a major setback, as they have likely expressed their cautious views by raising cash or employing hedges or outright bets against the market.

Such caution is confirmed when analyzing recent equity option activity, as equity option buyers are expressing the highest degree of pessimism since July 2013 (as seen in the first chart below). Plus, the four-week moving average of the percentage of bullish respondents in the American Association of Individual Investors (AAII) poll is again at pessimistic extremes that have preceded rallies (as evidenced in the second chart below).

The sentiment backdrop is growing more favorable for the bulls, but price action has to become more favorable, too, especially with the DJIA, SPX, and W5000 trading at historical resistance areas. A sustained move above these resistance areas, and the RUT moving above recent resistance from its 160-day moving average (currently situated at 1,135), would likely create more short covering or cause potential investors to move off the sidelines -- setting up the next leg of the rally and a thankful move from this dreadful trading range environment.

Fear in the Options Pits
The 10-day, customer-only, equity-only buy (to open) put volume vs. buy (to open) call volume -- the ratio of put volume to call volume is at its highest level since July 2013
SPX vs 10-Day BTO Put/Call Ratio Since January 2012

Retail investors are souring on the market ... at the wrong time, again?
SPX vs AAII Bulls Since 2011

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