What We're Expecting for Stocks in 2015

The key technical levels to watch for the VIX, RUT, XIV, and SPX in the new year

Dec 29, 2014 at 10:42 AM
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The following is a reprint of the market commentary from the January 2015 edition of The Option Advisor, published on December 18. For more information or to subscribe to The Option Advisor, click here.

As of this writing, the Fed's promise to be "patient" on interest rates seems to have snapped stocks out of the slump they endured during the first half of December -- suggesting the positive momentum that traditionally carries the S&P 500 Index (SPX) higher into year-end may finally be gaining traction. Of course, for a market that makes 2% moves on the basis of what is, for all intents and purposes, an adjective update by the central bank, there are certainly no guarantees that 2015 will bring us smooth, low-volatility gains.

In my Dec. 7 "Chart of the Week" column, I discussed the significance of the 40 level on the VelocityShares Daily Inverse VIX Short-Term ETN (XIV). During the bulk of 2014, moves above 40 for this "inverse volatility" vehicle have corresponded with positive returns for the S&P, while breaks below this round-number level have been reliable indicators of volatility spikes (and coincident equity sell-offs). Indeed, once again, the XIV rejection at 40 earlier this month coincided with fresh pain for stocks, even as the action in the major equity indices themselves failed to offer any hints of trouble ahead.

In the short term, it will be worth shifting the focus a bit south, and watching XIV's progress as it works its way back up toward 36. This area marked a peak for the exchange-traded note back in January, and then switched roles to provide support in August. Just a couple of months later, a daily close below this level on Oct. 9 signaled an impending volatility spike. As XIV advances, a rejection at 36 could be an effective "canary in the coal mine" for an impending rough patch for stocks.

Daily Chart of XIV since January 2014

Looking beyond XIV, there are several other significant technical levels that should come into play for the major indices in 2015. The latest surge in the CBOE Volatility Index (VIX) topped out around 24, roughly double its November-December lows in the 12 region. Amid this week's bounce in stocks, the VIX quickly pulled back below 20 -- a round number that could continue to act as resistance on rallies, as it's double the index's current annual low of 10.28.

In fact, the VIX has spent most of the past two-and-a-half years sandwiched between 10 and 20. Since mid-June 2012, the index has notched only four weekly closes on the upside of this range, and zero below. Look for these decade levels to continue marking key tops and bottoms in the new year.

As you might expect when a benchmark trades around a major millennium mark, there's been a lot of chatter about S&P 2,000 lately. While it's obviously a nice round number, 2,000 holds some additional significance for the S&P, as this price point represents a near-exact tripling of the index's March 2009 low at 666.79. It wouldn't be surprising to see this area continue to act as a "magnet" for the S&P in the coming months, as these round-number milestones have a tendency to do.

In terms of support, any pullbacks by the S&P could be contained by one of two key long-term trendlines. Its 10-month moving average, located at 1,969.30, has been cushioning the index's dips since June 2012. Meanwhile, the 20-month moving average is at 1,849.20, or roughly 20% above the peaks set by the S&P directly prior to the bear markets that began in 2000 and 2007.

Speaking of "magnetic levels," the small-cap Russell 2000 Index (RUT) has spent a healthy portion of 2014 trying to break free of the gravitational pull of its 2013 close at 1,163.64. On the upside, the 1,200 level has capped rally attempts, and no wonder -- this round-number region represents roughly double RUT's March 2000 peak and October 2011 low, and approximately triple its 2008-2009 lows. It's no mystery, then, that profit-taking tends to overwhelm RUT every time it challenges this region.

As major equity indices attempt to mount sustained breakouts above significant round-number levels, a crucial question becomes: Is there enough buying power left on the sidelines to push stocks higher from here? Surveying a few of our favorite broad-market indicators, we find that total short interest on S&P components has declined 2.2% since the end of 2013, while the number of analyst "buy" ratings on these stocks has increased 1.7 percentage points over the same time frame. Meanwhile, the ratio of bulls in the weekly Investors Intelligence (II) survey has dropped to 49.5% from 61.6%.

So, during a period in which the S&P has gained about 11.5%, and set new record highs in the process, sentiment has increased only marginally at best, and -- in the case of the II survey -- actually deteriorated. While it would be short-sighted to overlook the significance of major round-number "magnets" that could continue to hold sway over stocks in the coming months, it seems fair to observe that we're not yet at the "euphoria" stage of this bull market. Keep an eye on XIV as a possible "tell" for short-term shocks, but look for the major equity indices to ultimately extend their climb up this persistent wall of worry in 2015.

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