Market Volatility: A Double-Edged Sword with Bullish Potentials
Understanding the Current State of the S&P 500
The S&P 500 index, or SPX, has emerged from the early April lows with remarkable resilience, maintaining most of its hard-earned gains. As it ascends to a critical resistance zone between 5,700 and 5,800, investors are holding their breath. Should this index manage to breach that resistance and hold above 5,800, we could be presented with a very bullish scenario.
However, the path to this potential victory is fraught with challenges. The SPX has encountered notable levels of support en route to this point, including 5,440, 5,300, and 5,100, not to mention the April lows hovering between 4,850 and 4,950. This uptick, while encouraging, must be analyzed with caution. If the SPX falters below the 5,800 mark, we would witness a concerning pattern of lower highs and lower lows—foreshadowing a bearish trend.
The S&P reached 5,700 earlier this week but has since experienced a setback. Continuing this downward trajectory would establish a new downtrend line, connecting February’s peaks with the fresh highs witnessed at 5,700. As we analyze this landscape, it’s essential for investors to remain vigilant.
Volatility Bands and Buy Signals
A critical signal emerged as the SPX crossed above 5,575 at the end of April, generating a full McMillan volatility band (MVB) buy signal. Currently, the target for this signal sits near the +4 standard deviation band around 6,000, while the -4 band rests at about 4,950 and is gradually rising. Notably, the volatility bands are tightening, indicating a decline in realized volatility—this could mean smoother sailing ahead.
Equity-only put-call ratios also reflect a bullish sentiment towards stocks. These ratios, which have been declining rapidly, remain on buy signals until a reversal occurs, which, as it stands, seems distant. Despite a couple of days of negative breadth this week, the overall market breadth signals remain positive, with oscillators still in buy territory.
Another crucial indicator lies in new highs versus new lows within the New York Stock Exchange. Currently, neither new lows nor new highs have surpassed the 100 mark consecutively, signaling a neutral state. Such stagnation implies neither bulls nor bears are strongly in control at the moment.
The VIX and Volatility Outlook
As we monitor the volatility index, or VIX, it reveals a slow decline. The “spike peak” buy signal from April 9 is still valid but will “expire” after today, given that it has been 22 trading days since the signal. A crucial VIX sell signal issued in mid-February remains in effect, as the VIX continues to close well above its 200-day moving average.
Despite patterns of volatility derivatives, a return to a bullish stance in the market remains elusive. The term structure of VIX futures exhibits downward sloping characteristics at short intervals and remains flat further down the curve. This inversion has persisted longer than any period since the pandemic-crisis in March 2020.
Realized Versus Implied Volatility
Currently, we find ourselves in a unique situation where realized volatility notably exceeds implied volatility. Historically, this condition, if substantial, often leads to positive outcomes for the market in the intermediate term. For our analysis, we utilize the 20-day historical volatility of the SPX (HV20) and compare that to VIX.
Recently, VIX dropped to 24, while HV20 still held firm around 50, resulting in a differential of -26. The high realized volatility can be attributed to the market experiencing swift 100-point fluctuations in both directions. Although we see implied volatility decline, realized volatility remains robust.
Based on our analysis over the years, we have often utilized a rise back above -10 as a viable buy signal for stocks, a strategy that has yielded positive results, barring the exceptional downturn in 2008. As of May 7, the HV20 stands at 40, while VIX is at 24, maintaining a difference of -16; it appears we could see a buy signal converging shortly.
Conclusion
In summary, while maintaining a low-delta “core” bearish position due to the lingering bearish implications in the SPX chart, potential bullish signals are emerging from various fronts. As the volatility landscape continues to evolve, seasoned investors must stay attuned to shifts in market dynamics. The ability to read the signs and act judiciously will be paramount in navigating these tumultuous waters. Stay prepared and vigilant as we march forward, keeping a keen eye on the market’s evolving narrative.
