- For the past 4.5 years, the VIX has been carving out a very tidy rounded bottom formation. Lower lows from 2012-2014 have been replaced by higher highs from 2014-present. This tells me the momentum has changed with regards to investors' risk preference. Said differently, investors have moved from net bullish to net bearish. Remember, elevated VIX readings are associated with drops in the market.
- Every single time the VIX has touched the rounded bottom in the past 4.5 years it subsequently spiked higher while equity markets dropped (significantly so in certain instances). In some cases, the spike in the VIX happened immediately after it touched the rounded bottom and in some cases it took 6-8 weeks, but it always happened. Never has it touched the bottom and then fallen below that point. Why should this time be any different?
- The VIX today is the most oversold it's been on a weekly basis since 2012. Experience tells me that the odds now favor a reversion to the zero line (ie. a rising VIX and a falling stock market
A few observations today on the weekly chart of the VIX:
Perhaps the June FOMC meeting will be the catalyst?
In the last 8 months, the VIX has found support at its rising trend line four times, including last week. The three times prior were followed by a fierce rally while equity markets tanked. Will this time be different?
After August's "awakening" in volatility, the VIX retraced most, but not all, of its gains. That's important from a technical point of view because it means that volatility is basing at a higher level than before. Said differently, it put in a higher low. Then, after a brief jump in mid-November, it retraced much of its gains again, but, same as last time, it never quite made it back to the October lows.
With today's sell-off in the markets, it's showing life once more. In fact, it has now jumped over its 50 and 200 day moving averages and its momentum indicators are both confirming the bullish move. If the VIX can close above 16.83 (its 50 dma), then the stage is set for a potential bull run - at least in the short term. The chances for a rally increase further if it can close above 18, which is above that descending green trendline shown above.
Bottom line: volatility is almost synonymous with market declines. If the VIX starts running, then equity bulls will need to take cover.
If you think the market is going to fall, but you're not comfortable shorting stocks, one option you may consider is the UVXY. From the fund's prospectus, UVXY "seeks daily results that match (before fees and expenses) two times (2x) the daily performance of the S&P 500 VIX Short-Term Futures Index." In simpler terms, it moves twice as much as the VIX. So, for example, if the VIX rises 2% on a given day, UVXY should rise 4%. If the VIX falls 5% then UVXY falls 10%. You get the idea.
UVXY is an exchange traded fund (ETF) just like any other ETF (SPY, XHB, QQQ, etc.) Rather than representing a group of stocks, however, it represents market volatility. The VIX rises when markets fall and falls when markets rise. Since the markets have gone up literally unchecked for five years, the VIX has been decimated along with UVXY, as you can see by the monthly chart above. Currently trading at $27, it is down 99.99% from its split-adjusted highs back in 2011. Yes, you're looking at that correctly - it was trading over $240,000/share just four years ago. As I said, the relentless climb in the equity markets have absolutely crushed any and all bearish investments.
Circling back to the title of this post, I believe that the UVXY currently offers an attractive risk/reward proposition. From a technical perspective, it appears that it's trying to put in a bottom - really for the first time since its inception. The $24-$25 level has now provided support for over five months and the volume is really starting to pick up. Again, this is the first time this ETF has found any sort of price stability in five consecutive years. That blue line of support is very clean so if you wanted to establish a long position, you have a very clear stop-loss point just below $24.00. Very minimal risk with potential huge upside.
I'm not the only one who's seeing opportunity here. Check this out:
This is a screen grab from Yahoo! Finance on long-dated UVXY January 2017 calls. The $170 strike has enormous open interest relative to the other strike prices. In other words, someone (or some people) is making a big-time bet (as in $ millions) that the markets are going to tank by January 2017. These calls are $143 out of the money (OTM)! Now of course these calls don't have to get in the money to make a profit, but you could get the same effect by buying the $100 strike or the $75 strike...so why go so far OTM if you didn't think something ugly was brewing?
The daily chart of the VIX is screaming for a bounce higher, if not something more. It's 1) deeply oversold on the daily, 2) it's retraced all the back to its breakout point from mid-August, and 3) it just hit stout support in the form of its 200 dma, which was formerly resistance.
As such, I would expect some rough sailing ahead for the stock market.
When the markets tanked on June 29, we saw a corresponding spike in the VIX - a measure of market volatility. I posted the following day that the breakout looked legit. Typically, there is an inverse correlation between the VIX and stock indices. As one rises, the other falls and vice versa. The breakout above the trading range noted by the green parallel lines should be concerning for stock bulls. The breakout was textbook from a technical point of view. First, there had been a well-defined trading range for several months, with multiple touches of both the upper and lower bands. Second, the breakout was forceful, leaving no doubt about its direction. Third, it immediately re-tested the upper boundary in the following days before resuming its uptrend. Lastly, momentum indicators are confirming the breakout. All of these elements suggest that the breakout is real and that we're seeing a meaningful trend change in volatility. At a minimum, I see the VIX re-testing its December 2014 highs of around 25, with a good chance that it makes a run for the October highs. As stated previously, a higher VIX implies lower stock prices. How much lower? Well, back in October when the VIX was 31, the S&P was sliding toward 1800 - a full 12% lower than current levels.
In what appears to be a no doubt breakout, the VIX has exploded this week on all of the bad news coming out of Greek, Puerto Rico, and China. The weekly chart above suggests that a retest of 31 is highly likely given the measured move. And, as you probably know, the VIX is inversely related to the stock markets. A rising VIX tends to equate to falling stocks and vice versa.
The last time the VIX touched 31 was back in October 2014. And where was the S&P 500? How about 1,821, or almost 12% below current levels. Risk is back so plan accordingly.
Note: My goal going forward will be to post more frequently but with less written commentary. Since this isn't my full time job and just a hobby, it's hard to dedicate the time necessary to write up a thoughtful commentary to accompany the chart analysis.
Have you noticed the wild swings in the markets lately? Yea, I have too. So what's changed?
QE3 "officially" ended in October 2014 and we saw a corresponding spike in volatility (to put it lightly). The daily graph above shows how the VIX blissfully crumbled lower for the first half of 2014 to the point where it was only a few ticks away from single digits - something not seen since right before the financial meltdown in 2007-2008. But then reality hit. Oh my gosh, the Fed's actually going to end QE? "Well crap," thought investors, "what's going to keep the market propped up? Certainly not earnings!"
And so just like that, reality began to hit the market and they started selling. Investors didn't want to be left holding the bag when the Fed pulled the punch bowl away. After some well-timed soothing words from various Fed officials, the markets settled back down for a couple months only to spike lower again in December. Then more soothing words followed by more rallies. And so on and so forth it's been.
The net result, as shown in the graph, is a VIX that's starting to consolidate at what I will characterize as an uncomfortably high level. The 50 dma crossed over the 200 dma back in October and has been rising ever since. Momentum indicators are staying stubbornly high suggesting further volatility ahead. So in the near term, it looks like the VIX might continue to chop up and down as it works itself into the corner of that wedge - perhaps another month or so. As with most consolidation patterns, it will have to then make a decision, break up or break down. Regular readers know I have been postulating that the markets are starting to roll over. If that's the case, then the VIX should break up and out of this pattern. Which, in turn, means that we need to buckle up as the road ahead is going to be very bumpy.
Here's a quick look at the daily VIX, or volatility index. The VIX is often referred to as the fear index or the fear gauge, as it represents one measure of the market's expectation of stock market volatility over the next 30 day period. Typically, a rising VIX corresponds to a falling stock market and vice versa.
Looking at the chart, you can see that the VIX bottomed in early July just a hair above 10.0, a very low reading from a historical standpoint. As a point of reference, the last time the VIX was this low was in early 2007, just a few months before the markets peaked.
I want to point out a couple observations here. First, the VIX recently failed to re-test its low from July marking a higher low. This is a sign of strength, along with a positive MACD and rising RSI, that suggests a bit of nervousness in the broader markets. Second, and this is purely observational, but note how many "shooting stars" we've seen recently, as shown by the green arrows. Shooting star candlesticks, or long tails, tend to be bearish as the daily highs are unable to hold into the close. Just about every spike in the VIX for the last month has been sold aggressively. Very few (any?) days in the past month have seen the VIX close at or near the top of its daily range. It's almost as if the VIX is being managed to alleviate any perceptions of problems in the overall economy. I say that tongue-in-cheek because that's exactly what I think is happening.
I argued on July 27 that the markets were looking awfully toppy and the VIX really had nowhere to go but up. While only 6 weeks have gone by since that post, the markets have continued to flounder and the VIX is indeed strengthening. Continue to watch the VIX here as it is certainly suggesting weak markets ahead.
Today I want to take a long-term look at a few of the major stock indices and see what they're telling us. The first graph above is a 10-year monthly chart of the QQQ, an ETF that tracks the NASDAQ 100 Index. After the major bottom in 2009, the QQQ has been trading in a very clean channel as marked by the green parallel lines. Each time it touches the upper or lower boundary, it reverses in the opposite direction. As you can see, we're currently sitting right at the upper channel line.
Now take a look at the MACD. It is by far and away the highest it's been in the last 10 years. Can it go higher? Sure. But honestly by how much? The full stochastics and RSI are saying the same thing. Both are registering at the highest levels they've been in the last 10 years. The full stochastics, which measures momentum and can only read between 0 and 100, is sitting at 98.65. There is literally only 1.35 left for it to move higher, which, conversely, means that there is 98.65 available for it to fall. While the Qs have been nothing but strength these last five years, the long-term indicators are flashing some serious warning signs.
My next chart is a weekly graph of the Russell 2000 Small Cap Index (RUT) going back about 5 years. Small caps tend to lead the general market both to the upside and to the downside. They are inherently more volatile as well, so the moves will be more pronounced than some of the larger indices such as the Dow or NASDAQ.
Multi-year support is shown by the green line. Each time RUT touched the line, as indicated by the red arrows, the index jumped higher. But something interesting has happened of late. After it touched the line in May, it tried to leap higher like it had done in the past. This time, however, the rally sputtered after only 6-7 weeks. After making a new all-time in late June by just the slightest of margins, it reversed lower and today is sitting right on that line once again.
Relative strength and MACD are flashing warning signals here as well. After topping in late 2013, its RSI has made a series of lower highs and lower lows. Same goes for the MACD. As of today, the RSI is sitting right on its mid-line and the MACD is threatening a bearish cross.
As the RUT is sitting on multi-year support in the form of its 50 week moving average AND the multi-year trend line, expect to see bulls really defend this area. Given the weakness displayed by the MACD and RSI, however, the bears might be gaining the upper hand.
Lastly, here is a 25-year monthly chart of the VIX, or Volatility Index. As defined by Wikipedia, "VIX is a trademarked ticker symbol for the Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 500 index options. Often referred to as the fear index or the fear gauge, it represents one measure of the market's expectation of stock market volatility over the next 30 day period." In a nutshell, elevated VIX readings indicate market turmoil while a low VIX indicates complacency.
A couple things jump out at me when looking at this chart. First, we're sitting on MAJOR long-term support in the 10-12 neighborhood. In the last 25 years, the VIX has only touched this area on a few occasions, after which a prolonged period of market volatility followed. Second, the MACD bottomed in 2011. While the VIX itself has continued to fall, the MACD has been making higher lows as indicated by the green trend line. This is an important non-confirmation.
The VIX will often swing wildly on a day-to-day basis, but taking a longer-term view smooths out many of the gyrations and allows you to see bigger trends at play. With this in mind, I have to ask the question: How much lower can the VIX really go? It would have to overcome immense pressure to penetrate below that green line for any extended period of time. In my opinion, the path of least resistance is now upwards.
The markets have been undeniably strong for the past five years. However, using the various tools that technical analysis offers, we can see that major changes are brewing. Each of the indices shown above are stretched to their long-term maximum/minimum. There is no more room to continue moving in the current direction. At the very least, I would expect the markets to start moving sideways from here, with a high probability of a correction (and perhaps a significant one at that) over the coming months & years.