IS LOW VOLATILITY GOOD?, A LOOK AT THE 2008 BREAK DOWN, 2008 MARKET MESSAGE, $SPX AND THE CURRENT BBAND STATUS, CURRENT SMALL-CAP SIGNAL IS BULLISH, KEY SUPPORT FOR QQQ, CONTRACTIONS FOR HOUSING, SEMICONDUCTOR AND RETAIL SPDRS

IS LOW VOLATILITY A GOOD THING?... Link for today's video. I am going to step back and look at some weekly charts using Bollinger Bands and the BandWidth indicator. As many of us are aware, volatility has declined over the last six months and trading ranges are quite narrow in the major stock indices. John Bollinger theorized that a volatility expansion should follow a volatility contraction. Bollinger Bands tell us when volatility is contracting, but they do not provide directional clues. Chartists should stay on alert in the coming weeks a range break is the first directional clue.

I am using Bollinger Bands with the default settings today (20 periods and 2 standard deviations). Just to clarify, BandWidth is the following: ((upper band - lower band)/middle band)). The middle band is a 20-period SMA and the bands are set 2 standard deviations above and below this SMA. Showing BandWidth as a percentage of the middle band normalizes the indicator and this means we can compare levels over a period of time. You can read more about Bollinger Bands and BandWidth in our ChartSchool.

Chart 1 shows the S&P 500 with three big advances over the last 20 years. The first advance extended from 1996 to 2000 and marked the dotcom bubble. Notice how BandWidth exceeded 20 percent on several occasions and these volatility surges occurred on price advances. It is a bit unusual to see volatility expand on advances. In contrast, the advance from 2004 to 2007 was completely different because BandWidth remained below 16% the entire time. BandWidth did not exceed 20% until early 2008, which is when the index moved sharply lower. The current advance looks similar to the advance from 2004 to 2007 (four years). Notice that BandWidth stayed below 20% during this period.

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Chart 1

BandWidth is currently at its lowest level since the bull market began in 2009. This means that Bollinger Bands are their narrowest as well. In fact, BandWidth is at its lowest level in over 20 years. This tells us that volatility is low, way low. Low volatility is actually a good thing because volatility is a measure of risk, though not the only measure for risk. Volatility will not always be low, but I think it supports the uptrend in stocks as long as it remains low.

Programming note: I will be on family vacation from Monday, July 6th to Friday, July 17th (two weeks). I will return to the Market Message and Art's Charts on Monday, July 20th. Have a happy 4th weekend!

FOCUSING ON THE 2008 BREAK DOWN... So what exactly happened at the end of 2007 and the beginning of 2008? Chart 2 shows the S&P 500 from 2003 to early 2008, which captures the bull run and the big reversal. Here are the key takeaways. First, notice that a double top formed from March 2007 until December 2007. This pattern extended for nine months and marked a well-defined topping process. Second, there where two support breaks to confirm the double top. The index broke first support at 1400 the first week of January and then broke support at 1360 a week later. Third, the index closed below the lower Bollinger Band the second week of January. And, finally, BandWidth broke out of its range with a surge above 16% in early January. This signaled a volatility expansion and an increase in risk. There were at least four signals for this major trend reversal and the reversal resulted in a bear market.

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Chart 2

2008 BREAKDOWN AND THE MARKET MESSAGE... For those keeping score at home, here is a screen shot of the Market Message the first two weeks of April. John Murphy and I might not have picked the exact top, but we did see the danger and did identify the break down in early January. In fact, John noted the break down on January 4th when the S&P 500 was at 1412 and suggested that the odds favor at least a 20% decline from the high, which was 1575. This projected a decline to the 1260 area.

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Chart 3

CURRENT BBAND STATUS FOR THE S&P 500... Turning to the current situation, I do not see a major top taking shape and I do not see a major support break on chart 4. However, SPY is in the midst of a Bollinger Band squeeze as volatility decreases. Bollinger Bands do not give us any directional clues so we have to watch for the break. Even though the advance has slowed the last four months, the overall trend is up and the bulls are still in control. A weekly close above the upper Bollinger Band would be bullish and could signal the start of another leg higher. A weekly close below the lower band would be bearish. Should we get a bearish signal, I would set the first target in the 195 area, which is a support zone marked by the December-January lows. A decline to the 195 area would be around 8.2% from the May high.

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Chart 4

Looking at the last three years, there are three items I would like to focus on with the Bollinger Bands. First, notice the three "squeezes" showing when the Bollinger Bands narrowed and when BandWidth dipped below 7% (blue shading). Such squeezes signal volatility contractions that should alert chartists to prepare for a move. The second feature shows prices "walking up the band". After the squeezes in December 2012 and April 2014, prices moved higher and closed above the upper band a few weeks later. This was a bullish signal as prices continued higher and walked up the upper band. The third item is the bear trap in October 2014. There was a Bollinger Band squeeze in September and then a weekly close below the lower band in October. This is generally bearish, but prices quickly rebounded and surged to the upper band. Not all signals work out.

CURRENT SMALL-CAP SIGNAL IS BULLISH ... Chart 5 shows the S&P SmallCap iShares (IJR) with a few Bollinger Band squeezes and a few breaks. The squeeze is set when BandWidth breaks below 10%. IJR broke out after squeezes in December 2012 and February 2014. There was an extended squeeze from February 2014 to September 2014 and then a downside break, which did not pan out because IJR quickly surged back above 110. The most recent signal was bullish with a squeeze in early March and a close above the upper back a week later. This signal has yet to be negated. We are in the midst of another squeeze as BandWidth hits a 15 year low. I would stay bullish until IJR closes below the lower band (114). A break here would target a decline to the next support zone in the 106-108 area.

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Chart 5

SETTING KEY SUPPORT FOR QQQ... Chart 6 shows the Nasdaq 100 ETF (QQQ) with three bullish breakouts over the last three years. A squeeze occurs with a move below 10% and the direction of the subsequent Bollinger Band break triggers the signal. This break can be up or down, and the last three have been to the upside. The March lows and lower Bollinger Band mark first support in the 104-105 area. A break here would target a decline to the 99 area, which is the next support zone. Such a decline would be around 11% from the current high.

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Chart 6

BBAND CONTRACTIONS FOR HOUSING, SEMIS AND RETAIL ... Chart 7 shows the Home Construction iShares (ITB) with BandWidth dipping below 10% for the second time in 12 months. The first dip occurred in July 2014 and ITB subsequently broke the lower band for a bearish signal. This signal reversed a few months later with a breakout in early November. After moving to new highs in April, ITB stalled out and BandWidth dipped below 10% here in June. This signals a volatility contraction and chartists should prepare for a volatility expansion. But which way?

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Chart 7

With 52-week highs in early 2015, I think the overall trend here is up and this favors further gains. A close above the upper band would be bullish and signal a continuation of this uptrend. A close below the green support zone would break the lower band and this would be bearish. Chart 8 shows the Retail SPDR (XRT) and chart 9 shows the Semiconductor SPDR (XSD). All three are bullish right now. Subsequent breakdowns by all three would be bearish for stocks overall.

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Chart 8

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Chart 9

VIDEO DETAILS... Link for today's video.

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Chart 10

PROGRAMMING NOTE... I will be on vacation from Monday, July 6th to Friday, July 17th (two weeks). I will return to the Market Message and Art's Chart on Monday, July 20th. Have a great 4th of July weekend!

Chart 11