Key Market Levels

The market traveled more than 200 SPX points this week on the way down and back. Here are all the instances where the SPX has traveled 200 points or more in the span of 5 consecutive trading days.

These instances are Apr of 2000, Sep/Oct/Nov of 2008, Aug of 2011, Aug of 2015 and now Jun of 2016. All of these are associated with market stress – Tech Bubble Burst, Lehman, AAA downgrade, Sudden China Devaluation and now Brexit. In all of these instances, there is no comparable where the rally ended this close to the All-Time-High. In each prior instance, the bounce ended well below -5% from the ATH. This is what makes this week’s recovery stand alone in the pantheon of sudden reversals. You have never had reversal this quickly this fast this close near a top. Only April of 2000 is somewhat similar and after an extended flat-market in 2000, the market turned into the bear market of 2000-2003.

The market now has to push above the 2100-2135 resistance area in order for anybody to get convinced that this rally will last. Right now, we are back right smack in the resistance area. Whether we break through depends on the following incoming data over the next 2-3 weeks:

US Non-Manufacturing PMI (Service PMI)
FOMC Minutes on Wednesday
ADP/BLS Job Reports (180K expected)
Corporate earnings

For the SPX, at resistance there is only 2 trades from a technical standpoint:

Short SPX with a stop over the breakout level which is at 2135
Long SPX after a breakout over 2135

This is going to be an epic tug of war here over the next 2-3 weeks as this data is rolling in.

Seasonally, July is the strongest summer month, which is not really saying much as the average July SPY return is 0.5% or the 6th weakest month in a year with 12 months. More notably, the year’s worst months on average are ahead of us. So you can’t expect seasonal factors to favor the bulls or bears here and the price will be entirely determined by external factors. However, you should expect seasonal factors and low volume to favor the bears in August and September.

Resistance levels on the topside is the 2100-2135 area where rally petered out multiple times over the past 2 months and over the past 2 years.

Support area is at the 2080 level where the 10-50MAs are and after that 2020-2040 area where the 100-200MAs are.

Key Volatility Levels:

We already discussed the historic nature of the VIX drop this week. The VIX futures curve also went from a “Bear Market” formation to a “Rally” formation in the span of one week. Technically this is defined as Contango going from negative to positive (above 5%) with the jump being more than 10 basis points. Here are all the prior occurrences of this phenomenon:

There are 3 instances in 2007, one during the European Crisis in 2010, one at the start of 2013 (Fiscal Cliff Deal), one at the end (Government Shutdown), end of 2014 and July of 2015.

2007 instances were precursors to the historically high volatility regime of 2008, from 2010-2014 they were amazing buying opportunities for XIV, in 2015 the August crash of 2015 followed soon after and now Brexit.

So no verdict can be reached from a technical standpoint, but the verdict is pretty clear once you take into account qualitative factors. These volatility curve formation changes were great times to short volatility when the result was “market positive” such as the attainment of a deal during the Fiscal Cliff or the Government Shutdown. But shorting volatility was precisely the wrong trade during times where no such deal was present. Nobody really looks at Brexit as a market positive. Christine Lagarde of the IMF projected that the UK GDP loss will be anywhere between -1.5% and -4.5% by 2019 and the IMF routinely overestimates growth. In other words, this is the best case scenario. So buying the dip here in XIV may not be a wise thing.

XIV had a heck of a rally this week with a nearly 20% run, but remains -20% over the past month. VXX is -20% for the week and +2% over the past month. However, the drop this week was way too fast for my taste and rushing in to buy the dip in XIV right here is probably a very bad idea. This is the “picking up pennies in front a steamroller” period now. VATR and VVIX remain very high and in all prior instance where VVIX remained high, a higher volatility regime ensued in the not so distant future. August is still ahead of us and August stands alone from a seasonal perspective as the one really bad month for XIV.