The past 5 - 6 weeks have seen
equity prices move considerably higher amid growing concerns regarding the
European debt crisis, the instability of the Middle East, and ultimately the
potential for a major economic slowdown in the United States.
U.S. equity indexes have
continued to climb the proverbial "Wall of Worry" since the first
week of June and have put on an incredible run. This past Friday saw the
S&P 500 Index (SPX) post the highest weekly close of 2012. The
perma-bears have been calling for a top and continue to run scared as light
volume and volatility have given the bulls an edge during August.
The next key overhead
resistance level for the S&P 500 Index to hurdle is the 1,440 resistance
zone lingering slightly overhead. I try to refrain from calling tops or
bottoms as I feel its a fool's game that ultimately humbles most market
prognosticators. If calling tops and bottoms was easy, investors and traders
alike would be able to produce monster gains all the time with uncanny
precision.
Instead of trying to predict
where the S&P 500 Index will find resistance or create an intermediate to
longer-term top, I will simply posit some technical and macro-economic data
that indicates we are likely closing in on a major top.
As stated above, the recent
rally we have seen has taken place on relatively light volume and plunging
volatility as measured by the Volatility Index (VIX).
Volatility Index (VIX) Weekly
Chart
As can be seen above, Friday's
weekly close for the VIX was the lowest in 2012 and ultimately one of the
lowest closing price levels in several years. While the VIX is trading at a
major intermediate low, there remains a lower support level going back to late
2006 and the early part of 2007 around the 10 price level.
The perma-bulls would argue
that we could see those 2006 - 2007 lows tested, but based on September
monthly VIX options the option market seemingly is arguing that we are
approaching an intermediate low in the Volatility Index. The chart below
illustrates the September VIX option chain based on Friday's closing prices.
Volatility Index (VIX)
September Monthly Option Chain
Larger Image
Price action is never wrong,
but many times a great deal of information can be acquired by simply
reviewing option prices. As can be seen above, the VIX closed on Friday at
13.45, a new 2012 low. However, when we consider the prices in the VIX
September option chain shown above I would point out that the VIX September
13 Puts are 0 bid.
What this essentially means is
that the VIX options market is saying that the Volatility Index is unlikely
to move below 13 in September. For readers unfamiliar with options, selling a
naked put or using a put credit spread are two trading structures that are
bullish regarding the underlying asset which in this case is the VIX.
The VIX September 13 puts are
offered at 0.05 on the ask, but are at 0 on the bid. This means that the VIX
market makers are not expecting to see the VIX move below 13. Clearly this is
not a guarantee as there is never a sure thing in financial markets. However,
this pricing situation for the September 13 VIX Puts is favorable for the
equity bears in September.
Another key element that
veteran option traders understand is that going into a quarterly expiration,
volatility typically recedes considerably. In light of that knowledge,
experienced option traders would assume that the S&P 500 Volatility Index
would have to rise in the intermediate term in order to allow for this
volatility contraction synonymous with quarterly expiration.
In layman's terms, the VIX
needs to move higher in the next 3 weeks based on the fact that the September
VIX 13 Puts are 0 bid. This is one of several clues that we could be nearing
a major top in the S&P 500 Index in the very near future.
When we look at a weekly chart
of the S&P 500 Index (SPX) it is obvious that we have a major longer term
breakout which occurred this past week. However, there remains additional
resistance overhead in the 1,440 - 1,450 price range.
S&P 500 Index (SPX) Weekly
Chart
While 1,440 might be a major
area where a significant top could form, a rally above this level cannot be
ruled out entirely. However, the chart above gives traders and investors a
context for where possible tops could form.
A reversal could play out
almost immediately at the current levels or we could move considerably higher
before finding major resistance that holds. For now, we do not have enough
evidence based on the S&P 500 Index price chart to proclaim that a top
has formed or will form in the near future.
Another underlying asset that
I monitor closely is copper futures. Generally speaking, if copper futures
are rallying economic conditions tend to be strong. The opposite can be said
when copper futures are under selling pressure. Recently copper futures
prices have been trading in a relatively tight trading range, but the
longer-term weekly chart shown below demonstrates that should prices start to
selloff, a major selloff could transpire.
Copper Futures
Weekly Chart
As shown above, there is a
monstrously large head and shoulders pattern (bearish) that goes back to
early 2010 that has formed on the weekly chart. Should the neckline of this
pattern get taken out on a weekly close the selling pressure that could transpire
could be devastating regarding the price of copper.
However, a major selloff in
copper would also indicate that economic conditions were weakening globally.
If copper triggers this bearish pattern, it would likely not be long before
other risk assets followed suit.
In addition to the possibility
that major selling pressure could await copper should that pattern trigger,
another macroeconomic data point would argue that economic conditions are
already starting to contract. The chart shown below, courtesy of Bloomberg,
illustrates the amount of waste hauled by railroad cars and the implicit
correlation to U.S. gross domestic product (GDP).
Waste Railcar Loads Versus GDP
Chart
Recently Zerohedge.com posited
an article that featured this chart and a link to that article is found HERE.
The article and the accompanying chart demonstrate that as more products are
produced, additional waste can be expected. As shown above, the amount of
waste being produced and hauled by railcar has fallen off a cliff and should
longer-term correlations remain intact a contraction in U.S. GDP is likely
not far away.
There are a multitude of other
topping triggers that I follow that are all screaming that a major
intermediate and possibly even a longer-term top is nearby. However, at the
moment the price action in the S&P 500 Index (SPX) is arguing otherwise.
Picking tops and bottoms in
advance is extremely difficult and generally foolhardy, however when multiple
triggers are going off regarding a possible type I pay close attention to
price action. While I will not go as far as to say where specifically a top
in the S&P 500 Index will form, I believe that a top is forthcoming and
could even occur in the next 2 - 3 weeks.
Price is never wrong, and
eventually I suspect that price will tell us what we wish to know. For now, I
am going into the next few weeks with caution regarding the upside in risk
assets. However, it is important to point out that I am not looking to get short
risk assets either.
My research indicates that a
major inflection point is coming and it could coincide with the Federal
Reserve's Jackson Hole summit. It could coincide with an event that we are
unaware of as well. At the moment risk in either direction seems high and
caution regardless of directional bias should be exercised. The next few
weeks should tell the ultimate tale.
Happy Trading!
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