Mid-week market update: After this week’s brutal sell-offs, the stock market is oversold enough for a bounce. The VIX Index has risen above its upper Bollinger Band, which is an oversold market condition and short-term buy signal.
If the market action in the past year is any guide, the potential for the S&P 500 is the 4720-4750 zone.
Relief rally ahead
There are other signs that the market is due for a relief rally. The CBOE put/call ratio spiked to 1 or more in the last two days. These have been good indicators that risk/reward is tilted to the upside in the short run. In the past 18 months, the bullish resolutions of these buy signals (grey bars) have greatly outnumbered the bearish resolutions (pink bars).
Remember the carnage in the NASDAQ? The ratio of NASDAQ 100 to S&P 500 has become sufficiently oversold that the NDX is due for some better performance.
Not out of the woods yet
Despite the signs that the market is about to undergo a bounce, psychology may not be sufficiently washed out yet. Even as the put/call ratio rose to panic levels, the term structure of the VIX Index is showing a mixed picture. The 9-day to 1-month VIX inverted yesterday, indicating fear, but the 1-month to 3-month ratio remained upward sloping. These readings are not consistent with a durable bottom.
Similarly, the Fear & Greed Index
is on the greedy side of neutral territory. Panic bottoms don’t look like this.
I had highlighted the sell signal from the intermediate-term breadth momentum oscillator. In the past, declines from this signal have ranged between 5% and 10%. The latest downdraft in the S&P 500 has only been -3.8% since the initiation of the sell signal. The bear leg from this signal may not be over.
Breadth indicators remain wobbly. All Advance-Decline Lines have broken down below their upside breakout levels, indicating broad-based weakness.
Opportunity and risk
In the short run, the market backdrop is more balanced between opportunity and risk. The effects of the Omicron wave appear to be peaking. Case counts in the UK, US, and Canada are starting to roll over, which is good news.
Q4 earnings season is proceeding. The market will experience both upside and downside volatility as individual companies report. The good news is forward EPS estimates are rising across all market cap bands.
On the other hand, Russia-Ukraine tensions are not abating. Russian troops are massing on the Ukrainian border in Belarus. The White House has warned that an attack could happen “on short notice”. US Secretary of State Anthony Blinken is scheduled to meet with Russian Foreign Minister Sergey Lavrov on Friday in Geneva. Neither side has indicated any hope of breakthroughs. The markets are understandably on edge and the tail-risk of an invasion could materialize at any time.
Don’t forget that the FOMC meeting is next week. Hawkish expectations are rising. The market expects four quarter-point rate hikes this year. Some strategists have even called for a half-point hike in March. Watch for signals about a reduction in the size of the Fed’s balance sheet from either the FOMC statement or from Powell during the press conference.
Subscribers received an alert this morning that my inner trader had closed his short position and stepped to the sidelines. He believes that the intermediate-term outlook is bearish and he will wait for a rally to re-enter his short position. While the market is oversold, the magnitude of downside risk far outweigh any short-term upside potential.