Trader’s Narrative

From City Slickers

This is a guest post by Wayne Whaley (CTA):

Before I share some statistics with you on the impact that positive September’s have on the last quarter, I’m reminded of a scene in one of my favorite comedies, “City Slickers”. Billy Crystal’s character Mitch fancies himself a cowboy and in an attempt to bond with Jack Parlance’ character Curly he pulls up next to him on the cattle run and whimsically wishes Curly a good day and ask him if he’s killed anybody today. Curly stares at Mitch, unamused and responds, “Nope but the day ain’t over yet”. Mitch fades back into the pack of his wannabe cowboy buddies, fearing that he might not live through the day.

So with the fact that September is up 4.4% and still has 8 trading days remaining, I hesitantly share the following statistics with you, hoping that I haven’t jinxed the rest of the month. I preface the table with the comment that September is historically the weakest calendar month of the year and the ability for the market to buck the trend is a sign of strength for the rest of the year. The table shows all Up Septembers since 1950 followed by the Pct Change in both October and the total 4th quarter.

Positive Septembers vs. October & 4th Quarter (for the S&P500):

There were only two significant fourth quarter losses following a positive September: in 1973 & 2007. Using the logic that “if the market can buck the seasonal trend, go with the trend”, since most November-Decembers are up, the losses in 2007 and 1973 were a very timely harbinger of worse things to come.

Kick back and catch up with what you may have missed at this weekend’s reading list. Here are just a few examples from news.tradersnarrative.com:

• The Bond War
• If You Want to Make Money Trading, Stop Thinking About Making Money Trading!
• The Financial Markets and Fear Itself
• Investors sceptical on stock market rebound
• Get a FREE Subscription to Financial Magazines
• A Rally Led by ‘Junk Stocks’
• The Ability to Not Trade: An Unappreciated Contributor to Successful Trading
• Bearish Divergence in the VIX and the S&P 500?
• From Ordering Steak and Lobster to Serving It
• The New Socialism
• The S&P 500 Conundrum
• Presidential cycle: Bullish for rest of this year

For the complete list, follow the graphic below:

And remember to check back regularly since there are interesting links added throughout the week.

Week Ahead: Inflation Worries Return

During the last week of February 2009 I mentioned the divergence between the CBOE volatility index and the S&P 500. There were arguments for either side because the divergence could have been viewed as either bullish or bearish, depending on your bias.

Although the market did fall another 13% from the day I wrote about the VIX divergence, it snapped back abruptly. During the intense rally (27% so far) the next conundrum was why the VIX continued to float above the long term support line. As of last week (Friday April 10th, 2009) it finally succumbed and broke below:

It may be difficult to see the breakdown in the chart above, but it is there. The VIX finally lost its 40 handle with a gap down. But this is just an initial breach with the next support level (previously resistance) at 30. So there’s a lot more work to be done to bring the VIX level near anywhere approximating “normal”. But it finally is moving in a more logical way and arguably, confirming the rally.

As the bulls and bears thrash it out at the knife edge of technical support, otherwise known as the 750 line on the S&P 500 index, the CBOE volatility index (VIX) is surprisingly calm:

As more and more days go by with the market dancing on the thin line marked by the November 2008 lows and the VIX staying much lower, the divergence gets more and more attention. In fact, the VIX has not even been able to muster a challenge to its January highs of 57. Like most indicators, this divergence can be interpreted several ways, depending on your existing bias.

Bullish
If you happen to already have bullish tendencies, then you’ll probably interpret this circumstance to mean that the market is healthy since this is the classic ‘bullish divergence’ in technical analysis. Also, back in October 2008 when the VIX first hit 80 (and beyond) that didn’t mark a definitive bottom - so why should be expect a high VIX reading at those levels again to have similar significance?

Bearish
If you happen to be a bear, then you’re probably thinking that the VIX must, at some point, be forced to revisit the highs it reached back in November 2008 before the market can truly find a lasting low. After all, if the VIX is so low (relatively speaking) that must mean that the options market is complacent. And no real bear market can be killed by complacency.

Personally, I’m not sure what to think. We are in a very strange market and it is fascinating to watch. But beyond that, if pressed I would slightly shuffle over to the bullish camp.

The CBOE volatility index is calculated based on the options market - which has been absolutely bonkers. By that I mean that it hasn’t followed the usual historical patterns. Over the past few months, I’ve struggled to make sense of it but I keep returning to just shrugging my shoulders and thinking that the options market has gone crazy.

What do you think is really going on? what does the VIX divergence mean? and the eccentricity of the options market?

The world central banks are busy injecting liquidity into the financial markets and the financial markets are busy injecting liquidity into the pants of investors. Today’s market was so bad about the only thing that can redeem it is just how bad it was.

For the third time we are at the precipice - 850 on the S&P 500 Index (SPX). I’m curious how this will influence the retail investors sentiment. If they will continue to be nonchalant or once again turn to historic pessimism.

We had 12 times the number of declining stocks to advancing stocks on the NYSE. For the Nasdaq the ratio was half. Not surprisingly then, well over 90% of the volume flowed from declining stocks.

There divergences popping up all over the place. The CBOE equity only put call ratio, for example, continued to act strangely when it didn’t even rise above 1.0 - in fact, since this waterfall down move began, it has managed to put in lower highs. First in mid September, then in early October and then now. Such a negative divergence would be bad news for the market, except for the fact that the options market has been absolutely crazy lately.

Another divergence that caught my attention was the Bullish Percent Index (of the S&P 500) compared with the S&P 500 Index itself:

Grasping at straws? Maybe. We are sitting at the ledge, peering down to who-knows-where. Paulson has just thrown up his hands, all but admitting that he has no idea what he is doing. Do you really expect the same person who oversaw this crisis in the making and who just a few months ago assured everyone about the soundness of the US financial markets to be the same person that would actually solve the problem?

We may even break down through the 850 “line in the sand” but even if we do, all may not be lost. Looking back through history, it isn’t rare to find lasting bottoms which occurred after a slight penetration of previous support levels. The most recent example would be the 2002-2003 bear market bottom.