PULLBACK IN VOLATILITY INDEX SUPPORTS SHORT-TERM MARKET BOUNCE -- S&P 500 CLOSES BACK ABOVE 200-DAY AVERAGE, BUT VOLUME IS LIGHT -- FINANCIALS AND SMALL CAPS STILL NEED TO CLEAR THEIR AUGUST HIGHS

VIX INDEX IS PULLING BACK... True to its history of trending in the opposite direction of stocks, the CBOE Volatility (VIX) Index continues to weaken after hitting a four-year high last Thursday (when the market bottomed). Chart 1 shows the VIX falling back to 23 and testing a short-term trendline drawn under its July/August lows. If that doesn't hold, a lot more support exists just below the 20 level which marks the March high (at 19.40) and the early August trough at 19.33. Supporting the lower level are the lines in Chart 2. They show the VIX closing below its 20-day moving average today (dotted line). That increases the odds that it will drop closer to its lower Bollinger band (currently at 18.66 and rising). The ultimate direction of the VIX will tell us a lot about the ultimate direction of the stock market. Right now, it's supporting a market bounce.

Chart 1

Chart 2

S&P 500 REGAINS 20- AND 200-DAY MOVING AVERAGES... The market had a reasonably good day today. All major market averages rose. More stocks rose than fell (3 to 1 on the big board and 2 to 1 on the Nasdaq). The only negative was light volume (although it did pick up a bit from yesterday's low level). Chart 3 shows the short-term improvement in the S&P 500. It accomplished three positives today. First, it closed just above its February peak at 1461. Second, it closed back over its 200-day moving average. And third, it closed over its 20-day average (green line). [Remember the VIX closed below its 20-day line today]. The hourly bars give a better view of some overhead resistance levels that the S&P needs to contend with. The first is the early August peak at 1466 and the down trendline drawn along the July/August highs. If it's able to get through that, the next potential barrier would be the late June low at 1484 (a 62% retracement of the summer decline). The most important resistance level of all is the mid-August peak at 1503 (if the rally carries that far).

Chart 3

Chart 4

FINANCIALS AND SMALL CAPS NEED TO DO MORE... Another way to determine if the current bounce has any staying power is to study its weakest groups -- like financials and small caps. Chart 5 shows the Financial SPDR (XLF) closing higher today (but on light volume). To improve its chart pattern, the XLF needs to clear its August highs near 35 (and its 50-day moving average). The Russell 2000 Small Cap Index in Chart 6 is still below its August high at 803 and its 200-day moving average. A close above those two barriers would certainly give the rest of the market a boost. So would a new August high by the financials. [While stock prices are bouncing, bond yields aren't. Please see my earlier piece on why rates may need to start rising if the stock rally is going to last].

Chart 5

Chart 6