Tuesday, August 3, 2010

Dow Breaking New Ground on its Own

Just a quick midday note since I was unable to put up a post yesterday: The market surged big yesterday, but it was mostly the Dow that made the major headway. If the Nasdaqs were leading the charge higher, I'd be looking more at the bullish side for a larger and longer sustained move to the upside. But the Nasdaqs are in fact lagging the worst of the major indices compared to the Dow. This often means that there is some fear underlying the market as people are only willing to buy up the big blue chip "safe" stocks and avoid the higher risk tech stocks. That's not the behavior I'd expect to see at the beginning of a new bull run. This combined with the fact that the entire rise from the July 2 low is now looking like a wedge, which is a corrective pattern, makes me believe that the market still needs to make new lows on the year. As long as the Nasdaq 100, Nasdaq Composite and S&P 500 stay below their highs, I think the risk:reward potential favors the bears who still have a slight edge in my opinion. If those indices to make new highs, then it would turn me neutral for the short term.

More later after the close.



Rob said...

Hey Todd,

Thanks for the update. I agree with you that the Dow leading and the Nasdaq lagging is a positive sign for the bearish case. What I have really been watching recently is the Vix. The Bollinger Bands have tightened considerably, especially within the past few sessions. And today was the second day in a row that the Vix came within a hair's breadth of touching its lower Bollinger Band. That's not to say it can't ride that lower BB for an extended period (e.g., Mar-Apr 2010), but it does give me more confidence that once the rally ends it will be followed by a big turn down.

PrincipleAnalysis_Blogspot_Com said...

Thanks for the VIX info. I'm curious what has happened in the past when the VIX's BB has tightened and the VIX was at similar levels it's at right now.

Rob said...

I looked at the Vix/BB charts going back to 2000, and I did not notice anything particularly important about the current Vix level (22-23). One Vix level that seems significant is 16ish -- the area of the October 2007 and May 2008 lows ... as well as the April lows of this year. I doubt we will get that low again, but if we are heading for a "double-top" in the main stock indexes similar to June+October 2007, perhaps that could happen.

I also did not notice anything important on the historical charts in terms of the Vix touching (or almost touching) the lower BB or the BB's tightening ... however, penetrating deeply below the lower BB for a session did seem to often be followed by a sharp Vix reversal up. As a bear, that is just what I would love to see any day now.

I think the sentiment is starting to align for the bear case nicely. Look at what we have seen in the past week. Big Wall St. names like Abby J. Cohen declaring there will be no double dip. Big academic/policy 'wonks' like Alan Blinder (w/ Mark Zandi) publishing a paper titled "How We Ended the Great Recession". And my personal favorite, Timmy Geithner's Aug 2 Op-ed in the New York Times, titled "Welcome to the Recovery". All of this, and the S&P is still almost 100 points below its April highs, and the deterioration of economic fundamentals is getting plainer to see every day.

PrincipleAnalysis_Blogspot_Com said...

Thanks for checking that out Rob. A close beneath the lower BB would be a nice setup to a sharp stock market decline once the VIX closes back inside the BB's. Not sure we'll get that with such low volume and a slow grind higher though.

As far as sentiment, I don't hear or see much of a presence on financial media about any concerns or push to be safe right now. Although there are a couple CNBC Fast Money guys that have been cautiously bearish and skeptical of the recent rally the past few weeks. I'd like to see what EWI puts on II and DSI regarding sentiment. That's the real hard data I think we can rely on regarding sentiment.

So what's your look for the short term (this week)?

Rob said...

I have to admit I am clueless about the short-term picture. I still have a high degree of confidence that 1220 in April was the top, and that this rally will stall and turn down hard somewhere in the 1130-1160 range. But I really have no sense of whether the peak will happen tomorrow or, say, three weeks from now. And I could even see a "double top" (retesting the very long-term trendline that the tape hit in April) occurring early this fall.

So I am currently staying away from any short-term bets; I see too much potential time-burn on puts, and not enough upside potential on calls. However, with the Vix this low, I have my eye on very long-term index puts; although I would first like to see the Vix penetrate the lower BB in a meaningful way rather than just graze above it. If the Vix dips enough, I might even buy a few short-term puts as high reward/risk lottery tickets.

Overall, I have found the market extremely confusing the past few weeks, and I have been bear-squeezed enough. So I am definitely going to "let the trade come to me"; and if it turns down without me, oh well, I already have some long-term puts that will catch the ride.

PrincipleAnalysis_Blogspot_Com said...

I hear you on the long term put options. I've had some on the QQQQ and SPY for a while now and I keep selling puts further out of the money when the VIX spikes and/or a temporary bottom appears to be in. I covered those puts though last week; a bit too early. So now I just have naked puts in and it's been a painful week. But with the VIX so low, I think buying options is the way to play it at this point. My opinion. Tough tough market right now though, volume is so low and the swings are a bit wild. But that's where we can make a lot of our money!