After an ugly week for the bulls, Friday served as a little consolidation. Exhausted sellers took a back seat and gave stocks a day to rest, which is far from saying that downside risk has evaporated.
In fact, implied volatility in S&P 500 options as measured by the CBOE Volatility Index (VIX) is inching up to 2011 highs and staying comfortably above the crucial support area at 30. When compared to the peak 2008 levels near 100, the current levels aren’t substantial, but they do indicate continued nervousness on the part of investors. A major spike in coming days/weeks could be taken as a contrary signal and may be indicative of a bottom building process. For now, however, it may be too early to focus on that.
The weekly chart of the S&P 500 doesn’t give the bulls much hope either. After the index last week fell out of the bear flag to the downside, the weekly chart gives us some perspective as to what the next potential support zone might look like. The area I am focusing on more as a target rather than a support zone spans from 1,010 up to 1,060, which is the bottoming formation range from 2010.
The stochastics oscillator on the weekly chart has come out of the August oversold levels. What I will be looking for over coming weeks is a divergence between price and stochastics such that price will break below the August lows but stochastics will form a higher low. Should such a formation occur, I would view it as fairly strong medium-term bottoming signal.
The U.S. dollar keeps rallying and serving as headwind for equities. As a potential upside target for the dollar index, note the double-bottoms formed in 2008 and 2011, which in 2008 led to a rally up to the high 80s as the chart below indicates.
If we compare this to the current chart of the dollar index and note the double-bottom and break out of resistance, just like in 2008, we might be able to take at least some clue from this that the dollar has a good amount of room to rally further and equities to remain under pressure for a while longer.
Last but not least, last week’s massive rally in the long end of the U.S. Treasury bond market should not come as a surprise to anyone given the FOMC announcement. Back in early July, I pointed out the narrowing trading range formation (blue lines) and potential breakout, which we can now see has materialized in a big manner.
The takeaway is simple, risk aversion on the part of investors is clear if we look to the bond market. I will also keep a close eye on the long end of the yield curve for clues of weakness in price (uptick in yields), as it could be an early indication of when a medium-term low in equities may be forming.
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