The Rally Is Intact—Barely

06/22/2009 12:00 pm EST

Focus: MARKETS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

Lawrence McMillan, editor of The Option Strategist, says that the bull move will last as long as the Standard & Poor’s 500 stays above support levels—which it is, by a little.

The broad market broke out to new highs again [recently], although it [has] struggled to hold those gains.

The first part of this ongoing rally was characterized by pretty much straight-up action. Since then there has been a series of breakouts, followed by consolidations and then further breakouts. This stair-step advance has been quite orderly in that each consolidation area has provided support for the next breakout. Thus, the 945-950 area for the Standard & Poor’s 500 index ($SPX) should now be support, followed by previous consolidation tops at 920-930, and then 870-880.

The 200-day moving average of $SPX has been overcome, a fact which has received more than its share of publicity. Perhaps more importantly, the rising 20-day moving average is now around 920, making that support area especially significant. So, the trend of $SPX is higher, and thus the $SPX chart remains bullish. For the record, a close below 915-920 would be a sell signal, and a close below 880 would mean the resumption of the bear market. (It closed above 921 Friday—Editor.)

Some sell signals have arisen, but they obviously have had little effect. One set of such sell signals occurred in the equity-only put-call ratios, but recent action has put those sell signals in doubt. Market breadth has generally been positive, generally remaining in overbought territory since mid-March. Such long periods of overbought activity are bullish, in that they signify a strong and wide participation of stocks in the rally.

Volatility indices ($VIX and $VXO) remain bullish also, because they are declining steadily. As long as they remain below their declining trend lines and declining 20-day moving averages, that is bullish for the stock market. A close above 32 by $VIX would be bearish, but that seems quite unlikely at any time soon. (It closed above 31.50 this week—Editor.) The actual 20-day historical volatility—often closely associated with $VIX—is below 25. So, there is a downward “pull” on $VIX in that regard.

Volatility derivatives have flirted with sell signals, too. The $VIX futures premium is currently at levels that in the past have been harbingers of market sell offs, as most of the contracts are trading with premiums near 3.00. We find this disconcerting, but as long as $SPX continues to rise, we will not fight the trend. The term structureof $VIX futures has now collapsed and is very overbought, with each futures month trading at a lower price than its next longer-term successor.

In summary, the outlook is bullish as long as $SPX remains above support. The nagging bearishness of the $VIX futures is something that should keep one on alert, but is “actionable” only if support is broken.

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