The past 5 – 6 weeks have seen equity prices move considerably
higher amid growing concerns regarding the European debt crisis, the
instability of the Middle East, and ultimately the potential for a major
economic slowdown in the United States.
U.S. equity indexes have continued to climb the proverbial “Wall of
Worry” since the first week of June and have put on an incredible run.
This past Friday saw the S&P 500 Index (SPX) post the highest weekly
close of 2012. The perma bears have been calling for a top and continue
to run scared as light volume and volatility have given the bulls an
edge during August.
The next key overhead resistance level for the S&P 500 Index to
hurdle is the 1,440 resistance zone lingering slightly overhead. I try
to refrain from calling tops or bottoms as I feel its a fool’s game that
ultimately humbles most market prognosticators. If
calling tops and bottoms was easy, investors and traders alike would be able to produce
monster gains all the time with uncanny precision.
Instead of trying to predict where the S&P 500 Index will find
resistance or create an intermediate to longer term top, I will simply
posit some technical and macro-economic data that indicates we are
likely closing in on a major top.
As stated above, the recent rally we have seen has taken place on
relatively light volume and plunging volatility as measured by the
Volatility Index (VIX).
Volatility Index (VIX) Weekly Chart
Volatility Index (VIX) Weekly Chart
As can be seen above, Friday’s weekly close for the VIX was the
lowest in 2012 and ultimately one of the lowest closing price levels in
several years. While the VIX is trading at a major intermediate low,
there remains a lower support level going back to late 2006 and the
early part of 2007 around the 10 price level.
The perma bulls would argue that we could see those 2006 – 2007 lows
tested, but based on September monthly VIX options the option market
seemingly is arguing that we are approaching an intermediate low in the
Volatility Index. The chart below illustrates the September VIX option
chain based on Friday’s closing prices.
Volatility Index (VIX) September Monthly Option Chain
Volatility Index (VIX) September Monthly Option Chain
Price action is never wrong, but many times a great deal of
information can be acquired by simply reviewing option prices. As can be
seen above, the VIX closed on Friday at 13.45, a new 2012 low. However,
when we consider the prices in the VIX September option chain shown
above I would point out that the VIX September 13 Puts are 0 bid.
What this essentially means is that the VIX options market is saying
that the Volatility Index is unlikely to move below 13 in September. For
readers unfamiliar with options, selling a naked put or using a put
credit spread are two trading structures that are bullish regarding the
underlying asset which in this case is the VIX.
The VIX September 13 puts are offered at 0.05 on the ask, but are at 0
on the bid.
This means that the VIX market makers are not expecting to
see the VIX move below 13. Clearly this is not a guarantee as there is
never a sure thing in financial markets. However, this pricing situation
for the September 13 VIX Puts is favorable for the equity bears in
September.
In layman’s terms, the VIX needs to move higher in the next 3 weeks
based on the fact that the September VIX 13 Puts are 0 bid. This is one
of several clues that we could be nearing a major top in the S&P 500
Index in the very near future.
When we look at a weekly chart of the S&P 500 Index (SPX) it is
obvious that we have a major longer term breakout which occurred this
past week. However, there remains additional resistance overhead in the
1,440 – 1,450 price range.
S&P 500 Index (SPX) Weekly Chart
While 1,440 might be a major area where a significant top could form,
a rally above this level cannot be ruled out entirely. However, the
chart above gives traders and investors a context for where possible
tops could form.
A reversal could play out almost immediately at the current levels or
we could move considerably higher before finding major resistance that
holds. For now, we do not have enough evidence based on the S&P 500
Index price chart to proclaim that a top has formed or will form in the
near future.
Another underlying asset that I monitor closely is copper futures.
Generally speaking, if copper futures are rallying economic conditions
tend to be strong. The opposite can be said when copper futures are
under selling pressure. Recently copper futures prices have been trading
in a relatively tight trading range, but the longer term weekly chart
shown below demonstrates that should prices start to sell off, a major
sell off could transpire.
Copper Futures Weekly Chart
As shown above, there is a monstrously large head and shoulders
pattern (bearish) that goes back to early 2010 that has formed on the
weekly chart. Should the neckline of this pattern get taken out on a
weekly close the selling pressure that could transpire could be
devastating regarding the price of copper.
However, a major selloff in copper would also indicate that economic
conditions were weakening globally. If copper triggers this bearish
pattern, it would likely not be long before other risk assets followed
suit.
In addition to the possibility that major selling pressure could
await copper should that pattern trigger, another macroeconomic data
point would argue that economic conditions are already starting to
contract.
The chart shown below, courtesy of Bloomberg, illustrates the
amount of waste hauled by railroad cars and the implicit correlation to
U.S. gross domestic product (GDP).
Waste Railcar Loads Versus GDP Chart
Waste Railcar Loads Versus GDP Chart
Recently Zerohedge.com posited an article that featured this chart and a link to that article is found
HERE.
The article and the accompanying chart demonstrate that as more
products are produced, additional waste can be expected. As shown above,
the amount of waste being produced and hauled by railcar has fallen off
a cliff and should longer-term correlations remain intact a contraction
in U.S. GDP is likely not far away.
There are a multitude of other topping triggers that I follow that
are all screaming that a major intermediate and possibly even a
longer-term top is nearby. However, at the moment the price action in
the S&P 500 Index (SPX) is arguing otherwise.
Picking tops and bottoms in advance is extremely difficult and
generally foolhardy, however when multiple triggers are going off
regarding a possible type I pay close attention to price action. While I
will not go as far as to say where specifically a top in the S&P
500 Index will form, I believe that a top is forthcoming and could even
occur in the next 2 – 3 weeks.
Price is never wrong, and eventually I suspect that price will tell
us what we wish to know. For now, I am going into the next few weeks
with caution regarding the upside in risk assets. However, it is
important to point out that I am not looking to get short risk assets
either.
My research indicates that a major inflection point is coming and it
could coincide with the Federal Reserve’s Jackson Hole summit. It could
coincide with an event that we are unaware of as well. At the moment
risk in either direction seems high and caution regardless of
directional bias should be exercised. The next few weeks should tell the
ultimate tale.
Happy Trading!
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Chris Vermeulen & J.W. Jones
