The Market Could Move Sideways For Awhile

“THE OPTION STRATEGIST
Weekly Updater 5/1/09
by McMillan Analysis Corp.

Stock Market

The chart of $SPX has one very prominent feature — resistance at the 875-880 level. This has been tested several times and has held each time so far. The most recent test was today, as $SPX actually probed well through that area, but reversed sharply and closed well below it. A close above 880 would be bullish, but as overbought as the current market is, we don’t expect that to happen soon. On the downside, there is support near 830. If it is broken, a more negative view of the market would be warranted. But lacking either one, it is entirely possible that $SPX will continue to trade within a fairly narrow range — going sideways until some of the overbought conditions are relieved.

SPX Showing Resistance at 880

The equity-only put-call ratios are interesting. Both ratios have moved to very low levels, especially the standard ratio. They have recently edged upwards, creating what appear to be sell signals.

Market breadth is our most overbought indicator. It would be more “healthy” for the stock market if it backed off somewhat, with a few days of negative breadth, so that the market can ease out of overbought territory.

Volatility indices have continued to decline and that is bullish for the broad market. $VIX has now fallen below 37, but it is still well above the 20-day historical volatility of $SPX (the “benchmark” for $VIX), which currently is near 30. If $VIX rises back above 40, that would break the current downtrend and would thus be bearish. But otherwise, the declining $VIX is one of the more bullish indicators, and it isn’t “overbought.”

VIX dropping

In summary, this market is overbought and needs to work that off. The bullish way to do so would be to trade sideways to slightly lower — perhaps for several weeks. We rate this as the most likely scenario. The bearish way would be for the broad market to quickly fall back below support. While we think the current rally’s been too strong for a complete reverse and break of support, we’d have to respect it if it happened. The third — and, in our opinion, least likely — path would be for $SPX to break out over 880. That would entice a lot of sidelined mutual fund cash to enter the market. The fact that it hasn’t happened when there has been the support of such things as month-end window-dressing and the FOMC meeting this past Wednesday, pretty much indicates it won’t happen soon.”