Mixed Salad

Scanning through my momentum charts this weekend I see a pretty mixed salad – suggesting a continued low calorie diet for the bears. Some of my indicators claim it’s business as usual while others continue to show divergences pointing toward a possible correction looming in the not so distant future. But in summary I remain quite skeptical when it comes to the bearish case. The bulls are clearly leading the charge here.

I think the most stubbornly bullish chart is the VIX which suggest that complacency and faith in Bernanke’s put is at record highs:

For over six months now we have seen the bollinger band weave down and now our range has compressed to between 17 and 23 – that’s a whopping five handles. Back in the days we crossed five handles in a day. What’s really interesting however is the nature of the moves, which have largely contributed to a slow drop in the BB: Every time we hit anything resembling a buy signal the bears are literally being taken to the cleaners as volatility drops quickly in a matter of two or three days.

On top of price it is important to realize that volatility risk is quite considerable, especially for option buyers. Bear in mind that this affects both put and call holders. So if you think you can buy the dips with options and then reap the benefits on quick move up – think again.

There is an important chart however that stands in stark contrast with the VIX:

Obviously the 5-day MA looks a bit more bullish right now but still – there is a distinct divergence developing here which I believe needs to resolve itself eventually. Unless of course we are going to gyrate around for the next six to eight weeks, thus producing a ‘sideways consolidation’ and giving the bulls the momentum to take 2011 by the horns in January.

For an example of just that look no further than May 2009 – we had a similar pattern emerging and in the end we never saw much of a correction and bears got slaughtered. Granted – this is not 2009 and we are in a much narrower and controlled market now. But when I look at this divergence and compare it with recent patterns then I’m a bit surprised to not see at least a drop to SPX 1100. So given that perspective it’s quite disturbing that the bears cannot muster up more of a reversal here.

The NYMO:BPNYA ratio chart tells a similar story. Without much downside in equities we quickly found ourselves at what seems to be a new buy line for this current leg higher. If the bears can turn it around here we may actually see a real drop but if you contrast this chart with the VIX for instance then the bears would literally have to come out of the woodwork to force a reversal – no pun intended.

And if there is any chance for a bearish scenario – short or medium term – then it’s probably right now and here. My BB on the SPX was quite clear about an impending drop – which is what we got. And now we are back at the center line and the magic 1200 mark. In my opinion – once we are above that it will be extremely hard for the bears to steer the ship back down – so if it is to be it must happen on Monday.

Bonds have been really interesting as of late – especially on the long term yield side. The 20-year (shown via TLT) got smacked big time and found itself embedded below the 20% mark on my stochastic. It seems to want to breach however and I expect a little reversal here momentarily. If it happens I think the 100 mark should be well in its sights.

Finally the daily Zero – which is getting interesting. Yes, thus far it has kept us out of becoming overly bearish – or bullish for that matter. However, things are slowly shifting and I expect ‘something significant’ to happen by early January. Look – the channel I painted on the smoothed panel needs to be breached – either up or down. Because if equities keep riding higher with the smoothed signal remaining below the upper channel line then we are talking about a bearish divergence, which can be ignored for a while but not ad infinitum.

Of course – if the DZ pushes higher and above the zero mark then it would strongly suggest that any dreams of a meaningful downside correction should be abandoned until 2011.

Bottom Line:

I’m mostly in cash these days as I the upside risk (see VIX) is growing but downside risk also remains considerable. It’s the type of tape where I keep telling myself that there is nothing wrong with watching and only taking small positions. Of course we could see a blow off move to the upside – considering the potential for a seasonal Santa Rally I could be missing out on a big move up. But is it worth the risk?

Perhaps Monday we’ll get that answer. Looking at the charts above I think that now would be the time for the shorts to come out and drive the tape lower. Chances are that after Thanksgiving the train pretty much has left the station. And momentum usually remains with whatever transpired ahead of the holiday season.

There is however another thought that occurred to me – grant me a little thought experiment (i.e. mental masturbation). Let’s say we actually drop on Monday or Tuesday – how far will it really get us? There is a cluster of support starting at 1130 and the thin tape during the Christmas season would most likely not lead to a breach through all those support lines. But let’s just assume we drop though that as well and find ourselves again near 1040 in January. What do you think would happen? A complete take down in January? Or an instant snap back as institutional dip buyers get positioned in the near year?

As strange as it may sound – I don’t think this is the time for the bears to make a move. It’s probably best to let the bulls have their Santa Rally and push equities to new record highs. From there an attack must be forged – one that produces long red candles slicing through entire clusters of support in a matter of days. I don’t think this type of ‘condoned downside’ we have seen as of late has the type of mojo capable of posing a real threat to the longs. More likely these are continued retail pig shake outs and thus buying opportunities for the big boyz.

Cheers,

Mole