By Lawrence G. McMillan
The stock market had two strong rally days this week.
That was mostly because of the massive oversold condition that existed, and it was aided by news from Europe that central banks were easing off on the increase in interest rates. There is some hope that could be the case in the U.S. as well, although the Federal Reserve has given no signs of that being the case.
The S&P 500 /zigman2/quotes/210599714/realtime SPX -0.09% had made new intraday and closing lows at the end of September. The subsequent huge rally coincided with a change of the calendar to October. I doubt if there is any real connection between the rally and the month of October, although October is known as the “bear killer” month.
Yes, there have been some massive declines in October, but by month’s end, the market has usually bottomed and is headed higher. In some cases, major bear markets have ended in October (1974, 1987 and 2002, for example — although in all three cases there was a retest of the lows in December). In the current bear market, perhaps October 2023 would be a better target month for the low.
Regardless, some oversold conditions have rolled over to confirmed buy signals, and that is aiding the rally so far. There is support at the recent lows, near 3600 points. Overhead, there is resistance near 3900.
The two island reversals (pink circles on the accompanying SPX chart) and the blue trend lines are more substantial bearish items. An oversold rally usually reaches and slightly exceeds the declining 20-day moving average (MA), which currently is at about 3820. So a move toward 3900 would not be out of the question.
The previous McMillan Volatility Band (MVB) buy signal of early September was stopped out when SPX closed below the -4σ “modified Bollinger Band” in the last week of September. That was the first losing MVB trade in a while (denoted by a blue “B” on the SPX chart; red letters denote successful signals). A new MVB buy signal has now taken place, though, as of Oct. 3 (green “B” on the SPX chart). This new buy signal has as its target the +4σ Band, which is currently at about 4080 and moving sideways. It would be stopped out of SPX fell back below the -4σ Band once again.
Equity-only put-call ratios have finally rolled over and begun to decline. That is the definition of a buy signal, and these signals are coming from extremely oversold conditions (i.e., from very high on their charts). These new buy signals are confirmed by the computer programs that we use to analyze these charts. A move to new highs would stop out these new buy signals. Otherwise, they will remain in place as long as the ratios continue to decline. The total put-call ratio is also working on a new buy signal, but that one has not yet been confirmed.
Breadth has been swinging wildly back and forth. It was terrible at the end of September when SPX was making new year-to-date lows. It has improved greatly on the October rally (in fact, Oct. 4 was a 90% “up” day), but the bottom line is that the breadth oscillators are still on sell signals. They were so oversold and so negative that they have not been able to rise out of that state even with some recent strong days of positive breadth.
The number of new highs on the NYSE has not increased much, so this indicator (new highs vs. new lows) remains mired on the sell signal that has been in place since April.
The CBOE Volatility Index /zigman2/quotes/210598281/delayed VIX +1.86% continues to have dampened reactions in both directions. When SPX was making new year-to-date lows in late September, VIX did rise back to 35, but that is still a muted reaction to what was a very nasty market decline. Since then, as SPX has rallied, VIX has declined as one might expect. But the decline in VIX has been modest as well, as VIX remains well above its 200-day MA (and hence the trend of VIX sell signal remains in place).
Countering that intermediate-term trend sell signal is the fact that a new VIX “spike peak” buy signal was generated on Sept. 28 and remains in place. While both signals have stops (see the Follow-Up section for specifics), neither stop is imminent.
The construct of volatility derivatives has improved somewhat as far as its outlook for stocks goes, but it is still in a somewhat tenuous state. That is because the front-month October VIX futures continue to trade at a slightly higher price than November VIX futures at times, and the first three months have not resumed an upward slope. The same has been true of the CBOE Volatility Indices term structure, as the near-term indices have risen sharply at times.
In summary, we are maintaining our “core” bearish position because of the negative trend of SPX and the positive trend of VIX. However, we are trading oversold buy signals around that “core” position.
New recommendation: Harmonic
Harmonic Inc. /zigman2/quotes/202944345/composite HLIT -2.02% has been a strong stock recently, making new yearly highs even as the broad market has struggled. There does not seem to be a specific reason for the stock’s rise, other than a strong technical picture.
Buy 5 HLIT Oct (21) 12.5 calls
At a price of 1.10 or less.
HLIT: 13.32 Oct (21) 12.5 calls: offered at 1.45