DOLLAR SURGES AS EURO TUMBLES -- EUROPEAN STOCK INDICES ARE NOT IN GOOD SHAPE -- VIX BREAKOUT IS BEARISH -- PUT/CALL RATIO RISES
U.S. DOLLAR INDEX SURGES ... Today's Market Message was written by Arthur Hill. John Murphy will return tomorrow. - Editor
Comments from the European Central Bank (ECB) sent the euro tumbling and the U.S. Dollar Index ($USD) surging on Wednesday. Yves Mersch, an ECB council member, commented that the eurozone economies were at risk of a slow down. This led to speculation that the ECB will soon join the Fed in lowering interest rates. Chart 1 shows the U.S. Dollar Index with a falling wedge over the last four weeks. The index is holding above its November lows and could be preparing for an oversold bounce. A break above last week's high would argue for a continuation of the November-December surge. Broken support at 80 turns into resistance and this is the upside target. Keep in mind that the long-term trend is clearly down. Even an advance to 80 would be considered a bear market rally. Chart 3 shows the Euro Trust ETF (FXE) with a big decline from resistance over the last two days. A double top could be taking shape with key support from the December low.
Chart 1
Chart 2
Chart 3
MAJOR EUROPEAN INDICES SHOW WEAKNESS ... Many of the key European stock indices are already showing weakness and this reinforces the prospects of an economic slowdown in the eurozone. Chart 4 shows the Netherlands Amsterdam Index ($AEX) breaking double top support at 480 this week. Chart 5 shows the French CAC 40 Index ($CAC) with a massive head-and-shoulders pattern and a neckline support break this week. Chart 6 shows the Spanish Bolsa 35 Index ($IBEX) with a sharp decline over the last six weeks. The index remains above support at 13500, but has given back most of the September-October gains. Finally, Chart 7 shows that the German Dax Composite ($DAX) met resistance just above 8000 in June and has been in a trading range the last seven months. Even though the DAX is holding up, the other three European indices are down sharply and this points to an economic slowdown in the future.
Chart 4
Chart 5
Chart 6
Chart 7
AN UPTREND IN FEAR... The S&P 500 Volatility Index ($VIX) measures the fear factor with the implied volatility of SPX options. This fear factor rises as volatility increases and subsides as volatility decreases. There are two ways to use this indicator. We can look for extremes or we can look at the general direction. Chart 8 shows the VIX over the last six years. This is a weekly chart based on weekly closing levels for the VIX. The indicator traded above 17.5 until it broke support in October 2003 (green dotted line). The breakdown in the VIX started a downtrend in fear. Even though the S&P 500 bottomed well before this breakout, the support break in the VIX preceded a multi-year advance in the S&P 500. Buying is easier when you are not afraid. Taking the reverse of this signal, we can infer that a resistance breakout in the VIX would be bearish.
Chart 8
The VIX found support around 10 in July 2005 and moved into a large trading range for the next two years. There were surges in April 2005, June 2006 and March 2007, but all met resistance around 18. This changed in July 2007 when the VIX surged above 30 and broke resistance with its biggest move in years. This does not look like your garden-variety surge. In fact, it looks just the opposite of the support break in October 2003. The breakout signals a new uptrend in the fear factor and selling pressure is likely to outweigh buying pressure as long as fear is in the air.
PUT/CALL RATIO NEARS EXTREME... The CBOE Put/Call Ratio ($CPC) is a sentiment indicator that measures bearish and bullish extremes. Put options increase in value as a stock declines. Call options increase in value as a stock advances. Naturally, put volume surges during market declines and call volume surges during market advances (Chart 9). The Put/Call Ratio allows us to compare put volume against call volume. The ratio rises when put volume outpaces call volume and falls when call volume outpaces put volume. When the Put/Call Ratio reaches an extreme, it suggests that too many option traders are either bullish or bearish. Mr. Market, not being a very nice guy sometimes, has a habit of changing direction when too many players jump on one side.
Chart 9
Chart 10 shows the 10-day SMA of the CBOE Put/Call Ratio ($CPC) over the last 15 months. The indicator moved above 130 twice in 2007 to reach a bearish extreme. Notice that the S&P 500 bottomed around the time the Put/Call Ratio reached these extremes. The March extreme coincided with a bottom in the index, while the August extreme preceded the bottom by a week. The Put/Call Ratio recently surged above 1.05, but has yet to reach the levels seen in March and August (above 1.25). With the Put/Call Ration still below its prior extremes, the stock market may have further to fall before a tradable bottom forms. You can click on this chart to see the settings and save it to your Favorites.
Chart 10
