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The stock market, as measured by the S&P 500 Index
SPX,
sold off sharply once the new year began. This is partly due to the fact that traders did not want to take taxable gains at the end of 2023, so they deferred selling that they might have normally done until the new year. But there is more than that, as you will see when we go over the indicators. There has been some serious internal deterioration in the market.
The chart of SPX can be considered bullish as long as it is above 4600. That is the horizontal red line on the accompanying SPX chart. Any pullbacks which hold at or above that level can be considered “normal,” in that the chart would still have an upward bias. However, a breakdown below 4600, and especially below 4550 (December’s low) would be a major negative development.
At the end of last year, SPX had repeatedly climbed above its +4σ “modified Bollinger Band” (mBB). Now, it has fallen back far enough that a confirmed McMillan Volatility Band (MVB) sell signal has been generated (green “S” on chart). This sell signal has a target of the -4σ Band, which coincidentally is very close to 4600 right now. Of course, that Band will move as time passes, but it lends even more importance to the 4600 level.
Equity-only put-call ratios have rolled over to sell signals, according to the computer programs that we use to analyze their charts. Both ratios have reached the bottoms of their charts. That means they are overbought, and now they have curled upwards, setting off these sell signals. The fact that these sell signals are roughly occurring at the same level as the last sell signals in late July is also meaningful, for those July sell signals were quite profitable.
Market breadth had been extremely strong at the end of 2023, and both breadth oscillators became very overbought. But there was negative breadth at the end of 2023, and it has gotten more negative in the first two trading days of 2024. That has driven the breadth oscillators to sell signals. We know that these oscillators are subject to whipsaws, so we always require a two-day confirmation of any new signal. To that end, another day of negative breadth today (Thursday, January 4th) would confirm these breadth sell signals.
On the NYSE, New Highs have diminished in number, but they are still larger than the number of New Lows, so this indicator remains bullish. This buy signal will be stopped out if New Lows outnumber New Highs for two consecutive days on the NYSE.
The implied volatility indicators are much less bearish than the indicators discussed above. VIX
VIX
VX00,
hasn’t risen much during the selling that has taken place in SPX over the past four days. As long as VIX is subdued, that is positive for stocks. Specifically, there are two things we’re looking at: 1) the trend of VIX buy signal will remain in place as long as VIX continues to close below its 200-day Moving Average (which is currently just below 16), and 2) a warning sign would occur if VIX were to enter “spiking” mode — a gain of at least 3.00 points over any three-day or shorter time frame, using closing prices. That hasn’t happened either, somewhat surprisingly. VIX would enter “spiking” mode today if it closed above 15.45.
There is a more negative slant when one looks at realized volatility. The 20-day Historical Volatility of SPX (HV20) had fallen as low as 7%, but it is now back above 10%, and that is a sell signal for a system that we use — although it only occurs rarely. It has sometimes been an early warning sign for a major decline to follow and is therefore worth trading.
The construct of volatility derivatives remains bullish in its outlook for stocks. The term structures of the VIX futures and of the CBOE Volatility Indices continue to slope upward. Moreover, the VIX futures are trading with a healthy premium to VIX. The major warning sign here would be if the January VIX futures (the front month) rose above the price of February VIX futures. That is not imminent, for February is trading about 90 cents over January currently.
“The bullish seasonal periods following Thanksgiving have expired. ”
The bullish seasonal periods following Thanksgiving have expired. The Post-Thanksgiving trade overall was a very positive one, especially when measured in terms of the small-cap Russell 2000 Index
RUT.
However, the Santa Claus Rally, which encompasses the last five trading days of one year and the first two of the next, showed a loss this year. That usually has more negative implications going forward — at least for the short term.
In summary, we are still going to hold our “core” bullish position as long as SPX is above 4600. We have rolled up positions all along the way for months now, so some gains have been taken and the positions do/did not have a great deal of downside exposure. We will continue to trade other confirmed signals around that “core” position.
New recommendation: MVB sell signal
As noted above, a confirmed MVB sell signal has taken place. It was confirmed on January 2nd.
Buy 1 SPY Feb (16th) at-the-money put and Sell 1 SPY Feb (16th) put with a striking price 20 points lower.
This position has a target of the -4σ Band, which is currently near 4600. We will update the target weekly. Meanwhile, it would be stopped out if SPX were to close above the +4σ Band, which is currently at about 4830.
New recommendation: HV20 sell signal
The fact that realized volatility is increasing from a low level is generally a bad sign for stocks. In this case, “realized volatility” is the 20-day historical volatility of SPX, which we call HV20. So, we are going to add a position based on this signal.
Buy 1 SPY Feb (16th) at-the-money put and Sell 1 SPY Feb (16th) put with a striking price 20 points lower.
This position will be stopped out if HV20 falls back below 9%.
New recommendation: Santa failed sell-signal
When the typical Santa Claus Rally seven-day trading period produces a loss, it is generally a short-term problem for stocks. This was stated, poetically, by the system’s creator, the late Yale Hirsch: “If Santa Claus should fail to call, bears may come to Broad and Wall.”
We did some quick research and here’s what we found. Since the system was first published in 1969, there have been only 13 years in which the Santa Claus seasonal period produced a loss (this year being the 13th).
The previously ones are listed in the table below, along with the magnitude of the Santa Claus decline (those seven trading days over the year-end).
Year Santa Claus Decline SPX result over the next few weeks
1977-78 -0.7% Steady decline
1979-80 -2.2% Steady rise, then sharp decline
1981-82 -1.8% Steady decline
1984-85 -0.6% Steady rise, no decline
1990-91 -3.0% Quick decline, big rally
1992-93 -1.1% Quick small decline, small rally
1993-94 -0.1% Steady rise, then modest decline with bad news at end
1999-2000 -4.0% Quick Rally, steady eventually large decline
2004-05 -1.8% Quick decline, slow small rally
2007-08 -2.5% Sharp decline, followed by more but slower decline
2014-15 -3.0% Decline on days 1 and 2 of 2008, then a slow rally
2015-16 -2.3% Sharp decline, followed by retest, then rally
The only time there was virtually no decline at all was 1985 (fourth line in table). In addition, there were barely any declines in 1991, 2005 and 2015. But in other years, the bears had a decent trade. So. we are going to carefully watch this seasonal period, and act if there is a Santa Claus decline.
Buy 1 SPY Feb (16th) at-the-money put and Sell 1 SPY Feb (16th) put with a striking price 20 points lower. This position will be stopped out if SPX closes above 4800.
Follow-up action:
All stops are mental closing stops unless otherwise noted.
We are using a “standard” rolling procedure for our SPY spreads: in any vertical bull or bear spread, if the underlying hits the short strike, then roll the entire spread. That would be roll up in the case of a call bull spread or roll down in the case of a bear put spread. Stay in the same expiration and keep the distance between the strikes the same unless otherwise instructed.
Long 1 SPY
SPY
Jan (19th) 477 call: A spread was bought in line with the CBOE Equity-only put-call ratio buy signal. It has been rolled up several times. Now that the put-call ratio are rolling over to sell signals, this call should be sold.
Long 2 ES
ES,
Jan (19th) 60 calls: We will hold this position as long as the weighted put-call ratio chart for ES remains on a buy signal. And it is still on a buy signal, but has reached an extremely overbought state, so also set a trailing closing stop at 61. That is, sell these calls if ES closes below 61.
Long 4 XLP
XLP
Jan (19th) 72 calls: Raise the stop to 71.20.
Long 1 SPY Jan (19th) 477 call: This position was initially a long straddle. It was rolled up and the puts were sold. The calls were rolled up twice more. This is, in essence, our “core” bullish position. Roll the calls up every time they become at least eight points in-the-money.
Long 0 AVPT
AVPT,
Jan (19th) 8 calls: These calls were stopped out on January 2nd, when AVPT closed below 8.10.
Long 2 TECH
TECH,
Jan (19th) 70 calls: We will hold as long as weighted put-call ratio is on a buy signal.
Long 2 IWM
IWM
Jan (19th) 196 calls: This is our post-Thanksgiving seasonal position. Sell the calls since the seasonally bullish period ended with the trading January 3rd.
Long 1 SPY Feb (16th) 477 call and short 1 SPY Feb (16th) 497 call: This spread is based on the “New Highs vs. New Lows” buy signal. We will stop out of this position if New Lows on the NYSE exceed New Highs for two consecutive trading days. Otherwise, there is no price stop based on SPX. The spread has been rolled up previously.
Long 4 UNM Mar (15th) 45 calls: We will hold this position as long as the weighted put-call ratio of UNM
UNM,
remains on a buy signal.
Long 0 SPY Jan (5th) 172 calls: This is our position that is trading the Santa Claus Rally. It was exited at the close of trading on Wednesday, January 3rd.
Long 1 SPY Feb (16th) 480 call: This call was bought in line with the Cumulative Volume Breadth (CVB) buy signal. The entire premium is at risk here, since there really isn’t a stop-out for this trade.
Long 10 ESPR
ESPR,
Feb (16th) 3 calls: The stock reported the resolution of some pending litigation, and the market had hoped for a better settlement, so the stock sold off. The closing stop remains at 2.25.
Long 2 DIS June (21st) 90 puts: We will hold these puts as long as the weighted put-call ratio of DIS
DIS,
is on a sell signal.
All stops are mental closing stops unless otherwise noted.
Send questions to: lmcmillan@optionstrategist.com.
Lawrence G. McMillan is president of McMillan Analysis, a registered investment and commodity trading advisor. McMillan may hold positions in securities recommended in this report, both personally and in client accounts. He is an experienced trader and money manager and is the author of the best-selling book, Options as a Strategic Investment. www.optionstrategist.com
©McMillan Analysis Corporation is registered with the SEC as an investment advisor and with the CFTC as a commodity trading advisor. The information in this newsletter has been carefully compiled from sources believed to be reliable, but accuracy and completeness are not guaranteed. The officers or directors of McMillan Analysis Corporation, or accounts managed by such persons may have positions in the securities recommended in the advisory.
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