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General Market Analysis
June 8th, 2003
The Markets put in another nice rally early this week, but pulled back on Friday. So what does the market look like from here? Let's first look at some charts starting with the Indicators, VIX and the BPCOMPQ:
The VIX or Volatility index is ratio of put options to call options. It is a useful indicator because it indirectly measures market psychology. The VIX is like a contrarian indicator, when it's low, it means that more people are buying call options, and thus are bullish on the market. Contrarian theory tells us that the majority of people are wrong about the stock market, therefore when the masses are overly bullish, the market is usually topped out and about to tank, and vice versa.
The VIX can be used in two ways:
1. Usually the VIX is used to indicate when the psychological levels of the market are overly bullish or bearish. Overly bullish levels are in the mid 20's and lower, while overly bearish levels are in the upper 40's and higher. Traders use these levels to indicate when the market is at extremes, such as oversold or overbought. The old saying applies, when the VIX is low it's time to go, when the VIX is high, it's time to buy.
2. The VIX can also be used to forecast the market direction because of it's inverse correlation to the market direction. For example, by using technical analysis, if you decide the VIX is going to fall in the short term, the market will usually rise, and vice versa. Normal pattern or technical analysis can be preformed on the VIX an attempt to decipher short term market direction.
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VIX analysis:
During the past several weeks, I have pointed out that Positive Divergence was starting to show up in the VIX chart, and that a bounce was likely. The VIX has been slowly rising and in a shallow uptrend. The VIX could continue to bounce here and with minor resistance at about 25 and major resistance at about 26.4 (which was support that went all the way back to November.
Many of you also probably noted last week that the VIX was rising even on days that the market was rising - sort of a VIX anomaly as the VIX normally moves opposite to the market. However this anomaly usually happens when the VIX is at extreme levels (usually in the low 20's and in the high 40's). To understand what is happening here, you much understand the definition of the VIX. The VIX is simply the ratio of the number of put options over the number of call options - that's all it is. The VIX is used as a contrarian indicator by many technicians to interpret market psychology. Usually the 'masses' are wrong, hence the name contrarian. So how does this explain the anomaly of the market rallying and the VIX going up as well? I could be wrong, but what I think is happening is that people are betting a market top is near and thus are starting to buy put options to hedge against a market fall. Therefore, the possibility exists here that the market corrects for a little while, but then recovers and puts on another rally in the near future as people cover their shorts. We'll just have to see. A rally in the VIX will likely encounter major resistance at the former support area of 26.4.
Below is a long term view of the VIX, notice that the VIX is currently between support and resistance of 20 and 26.4 respectively. The VIX could do anything here as it is in no-mans land, i.e. it could continue to rally up to about 26.5, or it could enter another decline and test 20 or even 18. If it decides to rally, the market weakness from Friday will probably continue, however if it decides to fall to support levels, the market will start its rally again.
Mulit Year VIX Chart
Here is a longer term chart of the VIX: here you can see that 20 is really minor support in the big picture, with 18 being the real or major support level. This chart gives the "bulls" hope, and shows a very strong possibility that the VIX falls to 18, thus causing more market upside.
At this point, it is hard to say if the market will test 18, however I doubt it will in the near term as the VIX looks like it is trying to bounce here. Note that 18 could eventually be tested if the VIX rallies, finds resistance at 26.4, and then heads back down. I see two possible scenarios playing out here in the future; one bullish and the other bearish:
Possible Bullish Scenario:
This would manifest in the market as follows: The market would pullback here and test recent broken resistance levels or Fibonacci #'s (which would probably bring the VIX up to resistance). The VIX would start it's decent to 18, which would cause a second major rally in the general markets. This is the most likely scenario I see at this time.
Possible Bearish Scenario:
A bearish scenario would occur if the VIX rallies here, but does not stop at the 26.4 mega resistance line. If this 26.4 resistance area is broken to the upside, then I see a much larger pullback in store for the general markets.
Below is another chart I found very useful in predicting major market tops and bottoms over the last few years, however has the BPCOMPQ stopped working so well?
Normally, the BPCOMPQ indicator accurately predicted market tops when it was over 50, and market bottoms when it was under 30, however you can see that it has entered unprecedented levels in the high 60's. Even during the Bull Market of the 90's, the BPCOMPQ was not this high! If we use past history, the BPCOMPQ says the market is going to take a big nose dive soon. While I think the market could have a nice healthy pullback soon, I personally don't think it is going to make new lows again this year. Perhaps a large market pullback will stop at one of the Fibonacci #'s, thus bringing the BPCOMPQ back down to the 50's or high 40's.
Now on the Major Indices:
First the Nasdaq:
The Nasdaq is very very strong on a technical basis. The Nasdaq has rallied hard since March after the VIX indicator broke support through a large Symmetrical Triangle that begin it's downtrend to its current level in the low 20's. Not to toot my horn too much, but my newsletters have been very bullish on market conditions since mid March, you can go read my past newsletter from March, April, and May if you are a new subscriber to verify this. I am very happy with my predictions thus far, because I also subscribe to many other market newsletters, and many of them were bearish during March, April and some of May and were busy shorting the market and getting stopped out. Breakpoint Trades has been bullish, and you have seen this based on our newsletters and the very few "short" picks we have had on our watch list - we have primarily been profiling "long" picks since March.
Anyway, the Nasdaq has continued to make new higher highs and has even taken out its November highs. Two weeks ago, the Nasdaq broke significant resistance at 1560 which goes all the way back to May of 2002, this area will probably act as support now. The next target is about 1720 or the blue dotted line on the chart below. Simply amazing the strength the Nasdaq has shown during this rally. The next target is about 1720, however the Nasdaq might need to pullback first before hitting its target.
A pullback finally occurred after a large gap up on Friday, this could be the start of a larger pullback. If the pullback continues, likely areas of support would be the uptrend line, and the round number of 1600, and then lastly the 1560 support area.
Here's another look at the Nasdaq using Fibonacci #'s. A pullback would likely take the Nasdaq to retest the uptrend line, or 1600, and then 1560. However, if 1560 should fall, then look to on of the Fibonacci #'s to act as support - these are denoted in the chart below:
Nasdaq 60 minute chart
As you can see on the 60 minute chart, the Nasdaq is in process of pulling back. Obviously the uptrend line would be the 1st support, followed by 1600. If those should fail, then look to the dotted blue lines as support areas.
DOW daily chart:
The DOW Jones broke it's resistance level of 8870 last week, and even closed above the 9000 level. However notice that ugly inverted hammer candlestick that was formed on Fridays reversal? These inverted hammers usually signal market pullbacks (or inflection points) and occur on high volume (Friday was a high volume day). Therefore, I think there is a strong likely hood that the market continues the pullback that was started on Friday.
The big question is, how far will the pullback take the DOW? The first support area would be the round # of 9000, the second support area would be 8870.
DOW 60 minute chart:
The 60 minute chart gives you a closer view: The areas of support would be the uprend line, and the round # of 9000.
The S&P 500 daily chart:
The S&P 500 last week took out the mega important resistance area of 965. This is significant because not only did this resistance go all the way back to April 2002, it also was the venerable neckline of a multi year head and shoulders pattern (as you will see further below).
Like the DOW, notice the inverted hammer candlestick that was formed on Friday? Therefore, a strong likely hood exists that the S&P will pullback here in the short term. Obviously, the important test will be if the S&P now finds support on the broken resistance of 965? If so, this would be a significant event and a victory for the Bulls.
60 min S&P 500 chart:
On a short term basis, you can see that resistance at 65 was taken out last week.
If the pullback continues, look for the uptrend line to act as support, followed by one of the dotted lines, and hopefully 965.
Now let's look at the ultra long term:
Here you can clearly see the importance of the 965 level discussed above. As I discussed above, watch to see if 965 now acts as support for the S&P 500. If this level does hold as support, then the market will likely continue to make new highs this year.
Also notice how the S&P has formed a horizontal rectangle and it was broken to the upside as well. I view this break as another significant event and another notch for the Bulls for the following reasons: A book called, Encyclopedia of Chart Patterns by Thomas N. Bulkowski - Publisher: John Wiley & Sons, is a very interesting and useful book because the author has statistics on chart patterns. I looked out the statistics for Rectangle Bottoms that breakout to the upside, here are the results:
Average rise is 46% after breakout, with the most likely rise being about 20%! This means that the S&P 500 will likely rise to about 1155-1175. Note that a 20% rise from 965 is 1155! I see this as a high possibility occurrence.
Gold is also looking quite strong at the moment.
First off, the very bullish long term chart of the HUI un-hedged gold stocks (components of the HUI)
Study the chart below carefully. You can see that it would be very bullish if the HUI index can break 155. If this occurs, a possible price target of 230 could be possible. Unfortunately you cannot play the HUI directly like you can with the XAU, you can only play the stocks within the HUI, (components of the HUI)
However note from the chart below that the HUI can retest the uptrend line one more time before breaking out, this will depend what happens with the US dollar, see below:
However, I see the US dollar as critcal to golds strength or weakness. Usually, when the dollar falls, gold goes up, and vice versa, hence an inverse relationship exists. As many of you know, the US dollar has bee in a melt down for sometime now. Watch the dollar carefully here, if it contines to melt down, then gold will likely rise. However, if the US dollar bounces, then gold could enter a nice pullback here in the short term.
The US dollar is nearing support multi year support levels, and a bounce is probably likely soon, which could cause more of a pullback in gold
The Russian Market is doing nicely here as it took out its all time high of 5400. Unlike our US stock market, the Russian stock market is in a long term bull market much like the US market was in the 90's or a Secular Bull Market. Since 5400 was taken out, more gains seem likely here.
The tradeable stockfund (TRF) mirrors the Russian stock market very well and I have been long since 20.75. Hopefully some of you have taken advantage of this. 26.60 is resistance and will likely be taken out soon, the blue lines are support areas.
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