The Bears Are in the Saddle Again

11/21/2007 12:00 am EST

Focus: MARKETS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

Lawrence McMillan, editor of the Option Strategist, says the market’s tone has turned negative and the bears appear to have the upper hand for now.

The Standard & Poor’s 500 index was the lone holdout against an increasingly negative array of technical indicators. And, for a while, it was doing a stellar job as the index bounced off the 1490 support five times between October 22nd and November 5th.

All the while, the underpinnings were deteriorating as the VIX and put-call ratios issued sell signals. Finally, on November 7th, the S&P plunged below 1490 and a torrent of selling erupted after that, sending it down to 1450 in just a few hours’ trading.

This leaves resistance from 1490 up to 1520, and reactivates the support levels from the August-September [period]. There is support at 1450 and at 1430. A break below 1430 would likely augur a full retest of the August closing lows at 1410, and possibly the intraday lows at 1370.

Market breadth has been quite poor. The “stocks only” data has seen [at least] two more 90% down days. While these indicate potential short-term bounces, from a longer-term perspective, they [also suggest] a bearish trend in the market.

Both breadth oscillators reached severely oversold status. Thus, they are set up to turn bullish if the market can put together a couple of days in which advances outnumber declines. But be sure to wait for confirmation, for buying into a falling, oversold market can be a very nasty experience.

Volatility indices (VIX and VXO) started to head higher on November 1st. This was something of a dramatic reversal, because on October 31st, the VIX had closed below 19—a seemingly bullish development. But as selling picked up in November, so did VIX. It made new post—August highs and bearishly established an up trend.

As long as VIX continues to climb, it is considered to be on a sell signal. What we’re now watching for as a potential reversal to this bearishness in VIX is for a spike peak on its chart. Recently the VIX spiked up above 29, and reversed to close [lower], so that’s potentially a positive development.

In summary, we’ve turned bearish. When the S&P was above 1490, we were inclined to give the bullish case the benefit of the doubt, and that was the correct inclination, as evidenced by repeated rallies off support or out of oversold conditions. But now that the trend has rolled over, we have the opposite take on things: rallies towards 1490 are meant to be sold, and oversold conditions are to be viewed with caution.

Certainly, with the market this oversold, there will be sharp but short-lived rallies. We will not chase them as long as the S&P remains below what is now resistance at 1490. If you’ll recall, there were at least five attractive selling opportunities at the 1490 level back in August and September. More may lie in the near future.

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