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Wednesday, November 19, 2008

Charts of S&P and Vix, and the Search for a Market Bottom

My column today, Are Oil-Rich Sheiks Being Scared Into Gold?, is pretty bearish on everything but gold. That said, I also wouldn't be surprised to see a broad market rally this next week. In 13 of the last 15 years, the week before Thanksgiving has been a positive one in the market.

And that, in turn, could be the basis for a Santa Claus rally in a very oversold market.Three common indicators used to find a bottom are the bull/bear ratio, convergence/divergence, and capitulation as measured by the VIX (or fear) Index.

Note that I'm talking about "a" bottom, not "the" bottom. The Dow’s low of 1932 was preceded by at least seven levels that were considered major market bottoms. Looking at today’s market, we aren't looking for THE bottom, we're looking for a tradeable bottom that can be a springboard for a sustainable (several weeks to several months) counter trend rally.

Bull/Bear Ratio: Investors Intelligence surveys 140 financial newsletter writers to determine whether they are leaning bullish or bearish in their opinions to subscribers. The current bull/bear ratio of 0.44 is one of the lowest on record.

Verdict: the bull/bear ratio is a contrary indicator, so this is bullish.

Convergence/Divergence: A unanimous signal from the major benchmarks carries more weight than a fragmented signal. The markets all put in significant lows on October 27th. The Dow hasn't tested that low yet, but both the the Nasdaq (QQQQ) and S&P 500 did. Some will say the Dow has come close enough, others say not yet.

Verdict: Jury is still out. If they all make new lows, or bounce from their recent levels, that will tell us something.

Capitulation is somewhat linked to the VIX, which hit a record intraday level on October 24th and closed at a record level on October 27th. Futures were down limit the night before. There were some indications of panic but when the pit session opened, the stock market rallied back, showing limited downside market action. What we didn’t see was a record spike in volume.
Looking at the chart, you can see that the VIX has backed off its highs. However, I wouldn't be surprised to see it test those highs again -- probably accompanying a swoon in the market.

Verdict: Jury still out. If the VIX trends lower again, that would be a bullish sign.

So far, the evidence is inconclusive. We could see the regular Thankgiving rally and that could lead to a Santa Claus rally. Or we could plunge to new lows pretty quickly.

I think external forces that could move the market is news on the potential auto industry bailout, which could go either way; better news on the dismal international trade picture, which I covered in today's Money and Markets column, which could send the market higher; and a worsening economic picture in China or the global economy generally, which could send it lower.

So many uncertainties! Stay tuned!
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