A Memorable Week
by Jerome "Mel" Hickerson, MarketsPath.com
The Friday session closed out a truly memorable week. To recap the week:
• Tuesday - A new 52 week high and a close above 1150, also a 52 week high. The week starts bullishly.
• Wednesday - China tightens credit; the markets fear the same here. Mild sell-off.
• Thursday - President Obama declares war on the banking system. The markets tumble.
• Friday - Mr. Bernanke's confirmation to another term is in doubt; the markets obviously fear the unknown and want him reappointed. The DOW has now lost 550 points in three days.
The markets took the salvo of punches and finished the week staggering. Yes, this pullback was telegraphed by the technicals; it was obviously coming. But the speed and timing were certainly expedited by our friends and comrades in Washington.
This was obviously the worst week since the rally began over ten months ago. Three successive days with double digit SPX losses, each day losing more than the day before. You're looking back at October 2008 to see such a streak. Yeah, the Plunge. But can we say that the top is in and that the rally is done?
First, I want to remind you that back in November I started writing that we were watching a topping pattern and that I expected 1150 to be the top. So it isn't like the top just happening to be at 1150 would surprise me. But I think it is premature to pronounce the rally dead. History shows that rallies are like fires, they don't die easily. The embers smolder and often reignite several times before the fuel is exhausted. Weeks such as we just had are not unusual during rallies; they have simply been unusual during this rally.
There are many things on my mind as I write this; but I am going to try to limit myself to just a couple of the most important items. First, I want to briefly take a look at ugly red weeks and what they've meant in recent history, and second I want to discuss the rare activity of the VIX the last few days. Interestingly enough, both topics will once again touch upon the October 2007 market top.
I want to acknowledge that I am going to ignore 2008 in this discussion; if you believe we are going to relive 2008, feel free to stop reading. We may relive 2008; but I hope not and I believe it was a once in a generation type of event, a curiosity unlikely to be repeated soon.
The first chart shows the current rally by week, with white arrows pointing out the large red weeks that entered the week near the high and closed near the low of the week. A yellow arrow shows another large red week that entered near the middle of the bar. The examples during this rally have all bounced the following week.
I know, "things have changed this time." I heard that mantra repeated over and over the end of last October, too. The technicals are no weaker now than they were in late October; the largest difference is the War on Banks recently declared by the Administration. This indeed could be a rally killer. But I think its too soon to know that except by guessing. I prefer to not try to guess the news. I think it is possible that the Administration will find another bogey man to go after once they realize that attacking the banks won't help create a single job and could undo a lot progress that has been made this past year.
So an open minded trader, examining charts and looking at past examples can conclude that a bloody red week does not necessarily make a rally killer.
What about closing below the 50 day moving average? We did that in late March, late June, early July, and late October as well. The rally survived.
And what about the volume patterns, heavy on sell-offs and light on up days? That pattern has persisted since late May and the rally survived.
So, without getting too lost in the weeds here, I think the rally may revive and continue. Am I convinced? No. I still think 1150 may have been the top for months. But if you're convinced either way, I think its a mistake. This rally has shown a remarkable resilience and this 5% pullback was foreseen, needed, and may have been nothing more than a healthy correction.
Let's take a peek at the mother of all rallies, 2007. The two white arrows on the second chart are somewhat similar weeks and both occurred before the top was in. And yes, there are also several such weeks after the October top was in. But the presence of such weeks prior to the top is evidence that a week such as this proves nothing regarding whether the top is in or not.
Now, on to the second important topic. The action of the VIX this week was truly rare, truly remarkable. We saw the VIX jump a modest 6% on Wednesday's mild sell-off, burst a robust 19% Thursday, and then explode again on Friday for 23% more. Successive days with double digit increases are rare, occurring only 16 times in 20 years, and three of those were successive days in 2004, so we're really discussing an event that has happened only 14 times.
Since this is a rare event, let's see if we can learn much from an examination of the data. To begin, I plotted the last 10 events on a chart, just so I could visually observe and see if anything jumped out at me.
The chart is the third chart attached. The chart immediately supports my thesis that I have mentioned many times; that volatility occurs after a top and during the bottoming process.
But I was surprised to see how many times the wild VIX moves happen during a pullback shortly before the top. No less than half of the ten occasions on the chart happen within a couple of months prior to a top.
I found of particular interest the two in 2007. The July 27th event I remember clearly; we had put a 52 week high on the chart just a couple of day earlier and we were crashing, the rally was done done done. The market went nuts again a month later, just further confirming in my mind how the top was in, the rally was certainly done. (The August event is marked on Chart 2 with a red arrow, I wanted to show that such an event can even happen on a green week.)
And then six weeks later we were painting on the chart what turned out to be the real top. So don't be fooled folks. The top may be in; and it may yet be ahead. My guess is that we have yet one more run up coming in the weeks ahead.
Before I close this discussion of the VIX, let's drill down and see what happened in the days just after the event. 10 of 14 were green the following day (71.4%), 64.3% were green after two days, 85.7% were green after five days, and 71.4% were green after 10 days. (Data in chart attached.)
Therefore, odds would seem to favor a bounce for next week, and even for the following week. Bears beware.
Of course, the November 2008 example worked out quite well for the bears. But odds do not favor a repeat of that performance.
One thing is clear from the data: Volatility followed every time.
Note: Regular nightly report for Friday tomorrow.
