Bulls Need Help but the Stock Market Isn’t Willing to Give It

The S&P 500 Index, after nearly three weeks of remaining in a stable trading range, finally broke out, much to the surprise of market participants. However, this breakout was to the downside, creating significant resistance in the range between 5,560 and 5,650. This resistance area is just below the all-time high of 5,670, which makes it a formidable obstacle for the index to reach new highs. While it's still possible for the S&P 500 to set new records, the path to achieving that will now be more challenging than initially thought.

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There’s a notable gap on the S&P 500 chart from 5,463 to 5,000, and filling this gap could prove constructive for the market. However, if the current correction deepens and breaks below the 5,370 level, a heavier wave of selling could ensue, suggesting further downward pressure on the market.

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The McMillan volatility band (MVB) buy signal remains active, with its target still set at the upper +4σ band, currently around 5,750. This level has been moving sideways, indicating that there’s still potential for an upward move if the signal holds.

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Despite the selling pressure on September 3, equity-only put-call ratios have continued to decline. This was unexpected because the heavy selling didn’t coincide with a large spike in put volume, which usually accompanies such moves. As a result, the put-call ratios remain in buy territory for now.

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Market breadth, which tracks the number of advancing versus declining stocks, deteriorated on September 3. For the first time in a while, there’s a possibility that breadth oscillators will shift to a sell signal. It’s worth noting that the breadth of "stocks only" is weaker compared to the overall NYSE breadth. While a two-day confirmation is required for any change in the breadth indicator, the outlook could turn negative if the next few days show continued market weakness. This indicator has been bullish since mid-August, but that could change soon if market breadth worsens.

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On the positive side, new highs on the NYSE still outnumber new lows, keeping this indicator in bullish territory. This status will only change if new lows exceed new highs for two consecutive days, which has not yet occurred.

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Another important factor to consider is realized volatility, which has been declining. The 20-day historical volatility of the S&P 500, referred to as HV20, peaked at 23% a few weeks ago but has since fallen to 16%. This decline in volatility comes despite the large market moves on September 3. A further drop to 15% or lower would remove this as a potential bearish signal for stocks, indicating that the recent market volatility may not be as concerning as initially feared.

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The sharp drop in the market on September 3 caused a spike in the Cboe Volatility Index (VIX), pushing it back into “spiking mode.” This move effectively nullified the previous “spike peak” buy signal. However, another buy signal will be generated when VIX closes at least 3.0 points below its highest price since September 3. At that point, a new “spike peak” buy signal would be in play.

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Conversely, the VIX sell signal remains intact since VIX has yet to close below its 200-day moving average, which is currently at 14.50. As long as this level holds, the trend of the VIX sell signal stays in place.

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The volatility derivatives market continues to suggest a bullish outlook for stocks. Even after the heavy selling on September 3, the term structure of volatility indices maintains an upward slope. While the VIX futures curve has been distorted by the upcoming U.S. election, the CBOE volatility indices term structure may provide a clearer picture for assessing market volatility and the broader stock market.

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In conclusion, the market indicators present a mixed picture. While the S&P 500 has broken down from its previous trading range, signaling caution for bulls, other indicators like put-call ratios and new highs versus new lows remain supportive of a bullish outlook. The key level to watch is 5,370—if the S&P 500 closes below this point, it could signal a much deeper correction and lead to further selling pressure.

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New Recommendations:

1. Potential ‘spike peak’ buy signal: If VIX closes at least 3.0 points below its highest level post-September 3, a new buy signal will be triggered. In that case, the strategy is to buy one SPY (Oct. 18) at-the-money call and sell one SPY (Oct. 18) call with a strike price 20 points higher. If this trade is executed, it should be held for 22 trading days or until VIX reaches a new high.
2. Dentsply Sirona (XRAY): Last week’s conditional buy in XRAY was not triggered, but the recommendation remains active. If XRAY closes above 26, buy four XRAY (Oct. 18) 25 calls. The position should be held as long as the weighted put-call ratio remains on a buy signal.
3. Walgreens Boots Alliance (WBA): WBA’s potential buy signal is still in place after its removal from the Dow Jones Industrial Average. If WBA closes above 10.60, buy two WBA (Sept. 20) 10.5 calls. This trade is based on the historical trend of stocks removed from the Dow experiencing strong rallies weeks after their removal.

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Follow-up Actions:

For existing positions in SPY, CMG, AOS, and others, follow the standard rolling procedure. For SPY, if the underlying stock reaches the short strike, roll the entire spread while maintaining the same expiration and strike distance. For long positions in CMG and AOS, hold as long as their respective put-call ratios remain on buy signals.

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