VOLATILITY INDEXES ARE BOUNCING OFF MAJOR SUPPORT LINES -- THE VIX ALSO HAS A SEASONAL TENDENCY TO BOTTOM IN JULY -- RISING VOLATILITY IS USUALLY ASSOCIATED WITH A WEAKER STOCK MARKET
BOUNCING VIX TESTS 50-DAY MA... The CBOE Volatility (VIX) Index has been falling since March (as stocks have risen). The VIX peak in March near 53 coincided with the stock market bottom. A falling VIX is good for stocks since they trend in opposite directions. Correspondingly, a rising VIX is bearish for stocks. That's why this is a good time to take closer look at that contrary indicator. Chart 1 shows the VIX jumping since last Thursday (after a weak employment report) and after losing half its value since March. Two overhead resistance points worth watching are the 50-day moving average (at 31) and its mid-June peak at 32.77. A close above the higher number would confirm a VIX bottom and turn its trend higher (which would be negative for stocks). There are at least two good reasons for the VIX to start rallying from here. One is technical and the other seasonal. Let's start with the technical.
Chart 1
VIX IS BOUNCING OFF MAJOR SUPPORT LINE... Chart 2 plots weekly VIX bars over the last three years (with a logarithmic price scale). The chart shows the VIX starting to bounce off a rising support line that started in early 2007 (first arrow). That makes this a logical spot for the VIX to start rallying again. The weekly Commodity Channel Index (CCI) line at the bottom of the chart is also turning up from oversold territory (green circle) for the first time since last October (red arrow). The line on top of Chart 2 compares S&P 500 downturns with previous VIX upturns. An upside breakout in the VIX in July 2007 (circle) marked the first market peak. A VIX upturn in May 2008 (second arrow) marked the end of a market rally and another downturn. This bounce off the trendline (third arrow) appears to be coinciding with the end of another market rally.
Chart 2
VIX USUALLY RALLIES AT MIDYEAR ... This interesting bit of seasonal information comes courtesy of Larry McMillan's newsletter "The Options Strategist". In a recent article titled "Summer Seasonality", McMillan points out a distinct seasonal pattern in market volatility as measured by trends in the VIX. Over the last twenty years, the VIX has shown a tendency to decline during the second quarter (March through June). After that, it rallies sharply from the start of July until October when it peaks. That may account for the seasonal tendency for the market to weaken over the summer and form important bottoms during October. There's no guarantee that seasonal trend of the VIX will work this year (it doesn't work every year). McMillan points out, however that this year's trend in the VIX is following its historical seasonal trend pretty closely. Needless to say, a July bottom in the VIX would suggest that the market may be in for a weak summer. That fits into my view expressed on Friday that the S&P 500 has completed a short-term top and may be starting the formation of a "right shoulder" in a bottoming formation that could last until the autumn.
NASDAQ VOLATILITY INDEX IS RISING AS WELL ... In case you're wondering about the Nasdaq Volatility Index (VXN), Chart 3 shows it also bouncing off a major support line. The daily bars in Chart 4 show the VXN moving up to test its 50-day average and, more importantly, its mid-June peak at 32.63. The green line in Chart 4 shows the Nasdaq 100 Index trending inversely to the VXN. Given that inverse correction, it's logical to expect that an upside breakout in the VXN would have a negative on the Nasdaq 100 Index on which it is based. Chart 5 shows the NDX threatening to break its 50-day average to the downside. That would constitute another short-term sell signal. Its daily MACD lines continue to weaken as well. The market appears headed for a summer of lower stock prices and rising volatility.
Chart 3
Chart 4
Chart 5
