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The Trend Is Still Bullish
04/27/2009 12:00 pm EST
Larry McMillan, editor of The Option Strategist, says the market is still moving higher, but it looks overbought and may face a test soon.
To put it simply, the broad market remains quite strong and continues to gather strength. The Standard & Poor’s 500 index ($SPX) has not once pulled back even to its 20-day moving average since it was first crossed in early March. That is unusual, and by itself creates the first “overbought” condition. $SPX has registered a consistent series of higher highs and higher lows, which is bullish, and the 20-day moving average is rising.
The $SPX chart exhibits resistance near the late January and early February tops in the 875-880 area. That may prove to be a stumbling block for the market in its current overbought state. Any pullbacks—if limited to the general neighborhood of the 20-day moving average—would be healthy and thus would not disturb the intermediate-term bullish trend. However, a decline below support at 780-790 would be significantly bearish. We don’t expect that in the near term, but it is a significant support level.
The equity-only put-call ratios continue to decline rapidly, and that is bullish. Market breadth has been very positive, pushing the breadth oscillators deeply into overbought territory during most of the last two weeks.
On three occasions in the last month, breadth has weakened temporarily and short-term sell signals have been issued. When the bear market was raging, such sell signals immediately resulted in a sharp broad market decline. The fact that that is no longer the case, indicates that we are in an intermediate-term bullish phase now.
Volatility indices (VIX and VXO) have grudgingly, it seems, fallen to their lowest levels since last September. Even so, they remain in the mid-30s–an area which previously had only been associated with extreme volatility. The trendof volatility is lower, and that is bullish.
Volatility derivatives, on the other hand, are painting a mixed picture. The futures are all trading at a premium to VIX, and that will eventually lead to a (major?) sell signal. The term structure of the futures has flattened out, though, and as long as it continues to move in its current direction, that confirms the bullishness of the overall market.
In summary, the indicators are bullish. The only one that is not is the premium on the VIX futures, and that isn’t necessarily an immediate problem. However, many of these indicators are overbought ($SPX far above its moving average, put-call ratios at the bottom of their charts, and market breadth oscillators above +500), so that a sharp, but short-lived correction is possible.
However, as long as that correction doesn’t fall significantly below the 20-day moving average (say below 780), then the intermediate term trend is still bullish.Subscribe to The Option Strategist here…
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