The 'January Defect’ Could Slam Stocks if Buyers Don’t Step Up Quick

The S&P 500 Index (SPX) struggled to maintain the momentum from its significant surge on January 15, showing a more subdued performance on January 16. Despite this, there are signs that bullish investors are attempting to reverse the year’s sluggish start.

‍

A critical issue has been SPX breaking below the support level of 5,870 for several consecutive days, which removed a bullish signal from the chart and established a downward trend. The SPX chart highlights this trend with a descending blue line, while January 15's surge aligns with the declining 20-day moving average (MA). Significant resistance now looms between the current levels and the all-time high of 6,100. For the bulls to regain control, SPX must rally to new record highs.

‍

On the downside, SPX finds support at 5,780, the level that marked the rebound of its recent decline. This level also corresponds to the closure of the "island reversal" gap from November. Meanwhile, an increase in realized volatility (HV20) has caused the “modified Bollinger Bands” on the SPX chart to widen significantly, with neither the +4σ nor -4σ Bands being touched in recent sessions.

‍

The equity-only put-call ratios, which have been rising steadily since mid-December, remain a bearish indicator for stocks. Although the significant rally on January 15 temporarily paused their ascent, the ratios have not yet reversed. These metrics, calculated as 21-day moving averages, typically require sustained market action to shift. If these ratios begin to decline, it would indicate a bullish signal for the market.

‍

Market breadth, however, has started to improve. Both breadth oscillators have now generated confirmed buy signals, reflecting a positive shift in the market’s short-term dynamics. While these oscillators are prone to frequent reversals—as seen with the failed bullish attempt earlier in January—they are currently giving valid buy signals.

‍

This is because the oscillators had reached deeply oversold levels and have now risen out of that territory. Though being oversold is not inherently a buy signal, a market recovering from oversold conditions typically is.

‍

New lows on the NYSE have been dominant over new highs since mid-December, which prompted a sell signal. However, this signal was nullified on January 16, as new highs outpaced new lows for two consecutive days. Despite this improvement, the indicator has not yet issued a new buy signal. To do so, new highs must not only exceed new lows for two consecutive days but also surpass 100 on each of those days.

‍

Realized volatility continues to challenge the market. Both implied and realized volatility generally have bearish implications, and the 20-day historical volatility of SPX (HV20) remains in an uptrend, sustaining the current sell signal.

‍

The VIX has shown notable fluctuations, spiking up and down three times over the past three weeks. The initial spike resulted in a “spike peak” buy signal on December 19, which remains valid for 22 trading days, extending for another six days from now. Since then, two additional overlapping “spike peak” signals have occurred. While these secondary signals are not typically actionable, they remain marked on the VIX chart. The first overlapping signal has already been stopped out, but the second remains active.

‍

In summary, the market is navigating a complex environment of mixed signals. Resistance levels remain a hurdle for bullish momentum, while support levels provide some reassurance for downside protection. The ongoing trend of increasing realized volatility is a key challenge, as it tends to correlate with bearish market conditions. However, improvements in market breadth and potential buy signals from oscillators offer a glimmer of optimism for investors.

‍

For the bulls to decisively reassert control, a combination of declining put-call ratios, reduced volatility, and a rally to new highs would be necessary. Until then, the market remains in a precarious state, teetering between potential recovery and continued struggles.

‍