The Week Ahead: Will Volatility Ruin Your Holiday?

12/12/2014 10:46 am EST

Focus: MARKETS

Thomas Aspray

, Professional Trader & Analyst

Based on the panic low on Wednesday and the strong opening and late reversal Thursday, it’s certainly been a crazy week so far in the US stock market, so MoneyShow’s Tom Aspray studies the charts to see if this volatility is likely to continue.

As of Thursday’s close in the US stock market, it has already been a wild week as the Dow Industrials has had over a 160 point range each day this week. On Wednesday, the range was closer to 300 points as the Dow closed at 17,597 after opening at 17,797.

The stock market had opened strong on Thursday as the better than expected Retail Sales data encouraged the bargain hunters. As I noted before the opening, there were signs that the market had formed a panic low Wednesday, and as I discuss in the What to Watch section, even the weak close Thursday does not change this view.

Thursday’s late reversal in the stock market was triggered by a further collapse in crude oil as the widely watched $60 per barrel level was broken in late trading. I have been discussing the weak technical outlook for crude oil over the past few months. In early November, crude oil, along with gold were labeled the Two Worst Markets in Any Time Frame.

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The weekly chart shows that major support for crude oil, line a, was broken in early October, confirming the negative signals from the monthly volume analysis. The weekly OBV has turned negative several weeks earlier and it continues to make new lows, even though prices are hugging the weekly starc- band.

On the bottom of the chart is a plot of the open interest or number of outstanding crude oil contracts. There were rumors that the October 15 plunge in crude oil and the spike in bond prices was a result of hedge funds be forced to sell their long crude oil positions and cover their short positions in the bond market. The long-term downtrend in the open interest is consistent with long liquidation. The recent uptick may be an indication of new shorting.

Twenty years ago, one had to examine the charts to identify changes in volatility but now there are quite a few volatility indices that the trader and investor can monitor. For example, the CBOE Crude Oil ETF Volatility Index (‘Oil VIX,’ Ticker: (OVX)) measures the market's expectation of 30-day volatility of crude oil prices by applying the VIX® methodology to United States Oil Fund, LP (Ticker - USO) options spanning a wide range of strike prices.

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The daily chart of the OVX shows that the trend of declining volatility (line a) was broken on August 1. By September 26, the bottom formation (line b) had been completed as the OVX has doubled in the interim. A sharp downside reversal and a drop back below the 30-34 level is needed to signal that volatility has peaked.

More traders and investors are more familiar with the VIX, which is often referred to as the “fear index.”  The chart on the right is a plot of the S&P 500 with the VIX. Currently, the VIX has risen sharply to the 20 level after the prior week’s close of 11.82. As long as the VIX is rising, it is considered a negative for the stock market.

A true option expert, and old friend, Larry McMillan has done extensive research on the VIX and VIX futures. He has also developed several trading signal systems based on this data and published extensive research.

I have highlighted several times when the VIX has formed a weekly peak and then dropped the following week, though, in some cases, the VIX did not reach historically high levels.

For example, in September 2013 it peaked (point 1) and then turned lower signaling the end to a three-week correction. In 2014, the VIX peaked at 18.99 the week ending January 31, point 2. It then turned lower as the S&P 500 bottomed early the next week. Also in October, the VIX soared to a high of 21.99 the week the stock market bottomed, point 3. The week is not over yet, with the VIX currently at 20.06, so watch it this week to see if it turns down.

Of course, the very strong US dollar and the weakening demand for crude oil have been a double whammy for the energy market. Overseas investors have been pouring money into both the US bond and stock market.

Despite the continuing improvement in the US economic data—including the upward revision in GDP and the surprisingly strong November jobs growth—yields are still drifting lower. This is likely due, in part, to foreign investors searching for safety.

NEXT PAGE: What to Watch

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The weekly chart of the 10-Year T-Note yield shows what I labeled as a reverse head and shoulders bottom in May 2013. Yields have fallen much more than expected this year as deflationary forces build.  The next support—in terms of yield—is in the 2.074% area, line b. The uptrend in the MACD (line c) was broken at the start of the 2014, consistent with lower yields.

Not all bond fund holders have done well this year as I have argued that those searching for yield need to also pay attention to the charts. In September’s column Is the Junk Dump a Warning? I warned that the fund flows out of high yield bonds like the SPDR Barclays High Yield (JNK) were consistent with its negative technical outlook.

In Friday’s WSJ, it was reported that another $1.9 billion came out of junk bond funds in the past week. The daily chart of JNK shows a clear downtrend since July. Prices have plunged recently as the junk bonds of some smaller energy companies are yielding over 20% as their prices have plunged.

In a recent MarketWatch article, it was reported that energy companies “accounting for 22% of US high-yield issuance and 16% of loan issuance through December.” Investors worry about the increased risk of default in some of the smaller energy companies.

The economic news out of the EuroZone has shown little improvement. In my opinion, the wait and see attitude of the ECB is indefensible. If they wait too long to act next year, it will be a big mistake as I do not think the sharp decline in the euro will be enough to turn their economies around. I continue to think that the EuroZone markets will surprise many in 2015.

In the next two weeks, the economic focus will be on the FOMC meeting that starts on December 16, with the announcement and press conference the following day. There is also plenty of data on the housing market, manufacturing, and consumer sentiment before the end of the year.

  • December 15: Industrial Production, Housing Market Index, and the Empire State Manufacturing Survey.
  • December 16 : Housing Starts, PMI Flash Manufacturing Index.
  • December 17: Consumer Price Index.
  • December 18: PMI Services and Philadelphia Fed Survey.
  • December 22: Existing Home Sales and Chicago Fed National Activity Index.
  • December 23: Durable Goods, GDP, and New Home Sales.
  • December 29: Dallas Fed Manufacturing Survey.
  • December 30: S&P Case-Shiller HPI and Consumer Confidence.
  • December 31: Chicago PMI and Pending Home Sales.

What to Watch
The plunging crude oil prices have added to the global deflation fears as I noted a few weeks ago in What Are Global Bankers Afraid Of?  This is likely to be a concern as we head into the New Year. As we go to press before Friday’s session, I still think this week’s close could set the stage for the rest of the month.

In last Thursday’s Was That a Panic Low? I did a complete daily technical review so I will be skipping it in this abbreviated Week Ahead column.

NEXT PAGE: STOCKS

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On Wednesday, the ARMs Index—or TRIN—closed at 3.47, point 2.  This is the highest reading since February 3 when it closed at 3.42 (point 1). The market consolidated at the lows for two days last February before gapping to the upside and completing the bottom formation. Therefore, Wednesday’s reading is consistent with the formation of a panic low, though it could take several days to be completed.

The daily chart of the NYSE Composite shows that it has still failed to surpass the early September highs. The 38.2% Fibonacci retracement support from the October low is at 10,611 with the 50% level at 10,471.

The bullish sentiment, according to AAII, rose slightly last week to 45.02% up from 42.68%. With the bearish % at just 22.34%, neither number is consistent with the levels one would like to see at a major low.  

The 5-day MA of the % of S&P 500 stocks above their 50-day MAs has dropped from 82% to 77.81% over the past week but is still at high levels with the mean at 66.14. Therefore, a number of S&P 500 stocks are still vulnerable to a further decline.

In spite of these concerns, the question I posed last week Is the Bull Market Only Half Over? should still  be considered even if we do have a much sharper correction. It will not change the major trend, which is still clearly positive as the NYSE, S&P 500, and S&P 1550 A/D lines have all made new weekly and daily highs.

The economic outlook continues to improve and is likely to get even stronger in 2015. This is important as bear markets generally coincide with recessions. One of my favorite measures of the economy is the Leading Economic Indicator and it continues to look very strong.

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The weekly chart of the Spyder Trust (SPY) shows that we may trigger a weekly low close doji on Friday if the SPY closes below $206.80, which does look likely after Thursday’s close at $204.19. The rising 20-week EMA is at $201.07 with the starc- band at $199.40. There is long-term support in the $182 area, line a.

The S&P 500 A/D line made a convincing new high in late November and is still well above its rising WMA. The A/D line has major support at line b.

The weekly on-balance volume (OBV) has failed to make a new high with prices as indicated by line c. The daily OBV has also formed a divergence but it will take another week or so of lower-to-sideways-after before a typical top formation could be completed.

Of course, the tendency of the small-cap stocks to outperform the large-cap stocks over the next three weeks is well established. However, the iShares Russell 2000 (IWM) is still range bound and the breakout will determine whether we will see the ‘January effect’ this year.


NEXT PAGE: Sector Focus, Commodities, and Tom's Outlook

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This has clearly been a year when it has been important to be in the right sector. Since the start of the year, the Spyder Trust (SPY) is up 11.6% as it has badly lagged the Vanguard Utilities (VPU), which is up 22.49% in the same time period.

The small-caps have had a dismal year as the iShares Russell 2000 (IWM) is up just 1.71%, but that looks pretty good when compared to the 33.9% drop in the SPDR Oil & Gas Exploration ETF (XOP). This reinforces the working hard so that you will be in the right sectors in 2015..

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The sector review up through Thursday, December 11 shows that the Sector Select SPDR Health Care (XLV) is still leading the way up 26% while the recent drop in the iShares Dow Transportation (IYT) has dropped it into third place as it is up 21.8%.

The Powershares QQQ Trust (QQQ) is currently up 18%, which is a bit better than the 15.4% gain in the Sector Select SPDR Technology (XLK). The consumer staples, consumer discretionary, and material sector ETFs are still just showing single digit gains. Will they play catch up in 2015?

The SPDR Gold Trust (GLD) is back in positive territory for the year and the monthly chart shows that a doji was formed in November. Therefore, a close above $115.96 will trigger a monthly HCB buy signal.

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I am still a bit cautious as the break of monthly support, at line c, would typically result in a stronger decline. The monthly OBV is trying to turn up but is still well below its WMA. The weekly OBV (not shown) is now back above its WMA, which is a plus.

The Week Ahead
The last two weeks of the year can be quite choppy and I feel strongly that this is not a time to change your strategy. It is also a good time to not watch financial TV as they may encourage you to take action that you will later regret.

Last spring, you will recall that one of the financial channels labeled it the “Most Hated Stock Market Rally,” which kept many out of the market until it was much, much higher. They always need a story, so if the market does correct further over the short-term, expect to see more stories about why the stock market is not the place to be invested.

That does not mean you should be complacent, as it is important that you have hard stops in place on all your positions. No one can survive a big loser in their portfolio as they are difficult to recover from. As I previously recommended, if you have a double digit gainer, it is always a good idea to take partial profits and don’t let it turn into a loser.

As I am off on vacation, I want to wish all of you the best for the holiday season. The next Week Ahead column will be published in the New Year.

Don't forget to read Tom's latest Trading Lesson, A Six-Point Checklist for a Profitable 2015.

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