Both the S&P 500 Index and the DJ Transportation Index recently closed below their key operative upward sloping trendlines but then held important lower support levels and may attempt to turn higher again, but valuation and seasonal history tips the scale to the advantage of the downside.
Despite the weak nonfarm payroll report following a weak first quarter GDP report the week before and without much help from earnings reports, the S&P 500 Index held at support , in addition the iShares Transportation Average Index, typically a leading indicator also held an important but lower support level. The two charts below tell the story followed by the update for the VIX futures premium and VIX options data along with the US Dollar Index arguably the most important indicator last week.
Market Review
S&P 500 Index (SPX) 2022.2057.14 down 8.16 or -.40% for the week closing just above S1 support at 2050 after trading lower Friday and then reversing to close higher on the day. There was additional support at the 50-day moving average shown in red below, however both are well below the important upward sloping trendline, USTL that began February 11 at 1810.11. While it could continue higher, at 24 times reported 2015 earnings and without much help from first quarter reports further upside seems limited to the pivot high of 2111.05 made April 20.
In the event the decline continues, the second support at 2000, S2 above would be the place to look for the next reversal.
iShares Transportation Average Index (IYT) 138.70 down 2.37 points or -1.68% for the week having trading down to the possible double top trigger shown as the dotted line and below the 50-day moving average shown in red then reversing Friday. Although a long way below the upward sloping trendline, USTL that began January 20 at 114.91 this leading indicator may attempt to retest the previous highs that defined the possible double top around 146. However, should the decline continue and close below 136.60 activating the double top the a measuring objective would be down at 127, marked in the right margin as ? since Friday it was a potential downside measuring objective as the double top was not activated.
Confirming its status as a leading indicator notice the transports made a bottom on January 20 and then turned abruptly higher while the SPX retested the lows again in early February before making a double bottom on February 11.
CBOE Volatility Index? (VIX) 14.72 closed down .98 for the week after making an intraday low of 12.50 on April 20. Based on real-time prices of options on the S&P 500? Index, VIX reflects investors’ consensus view of future (30-day) expected stock market volatility.
The table below shows the VIX cash compared to the next two futures contracts as well as our calculation of Larry McMillan?s day-weighted average between the first and second months.
With 7 trading days until the May monthly expiration, the day weighting applied 35% to May and 65% to June for a 18.30 % premium shown above. Our alternative volume-weighted average between May and June regularly found in the Options Data Analysis section on our homepage was lower at 14.30%.
While day-to-day VIX changes offer little forecasting insight following the VIX futures premium helps since it measures expectations of tactical professional traders and money managers using VIX futures and options for hedging long portfolio risk.
The premium measures the amount the futures currently trade above or below the cash VIX, (contango or backwardation) until front month future converges with the VIX at expiration. Depending on the time to expiration, premiums for normal term structures during uptrends are 10% to 20% and decline when the VIX advances faster than the nearest future as the market declines and/or the futures decline as the front month expiration approaches. Premiums less than 10% suggest caution and negative premiums indicate oversold conditions. Last week the premium ranged between 10.56% and 14.30%
VIX Options
With a current 30-day Historical Volatility of 98.38 and 93.08 using Parkinson?s range method, the table below shows the Implied Volatility (IV) of the at-the-money VIX calls and puts using the futures prices based upon Friday?s closing option mid prices along with their respective month?s futures prices, since the options are priced from the tradable futures.
Compared to the current range historical volatility of 86.83 May at-the-money option prices are about right while the June options are slightly inexpensive relative to recent movement of the VIX futures.
Foremost Indicators
While much of last week?s commentary was about economic indicators and earnings reports, perhaps the most important one to watch was the US dollar reflecting changes in the Japanese yen and euro relative to the dollar. In an environment of undeclared competitive devaluations the macro story is about exchange rates or perhaps said another way, DXY drives the macro bus!
US Dollar Index (DX) 93.89 up .81 points or +.87% for the week after trading below the 94-93 support range Monday and then testing 92 Tuesday making an intraday low of 91.92 before reversing up to close up.32 for the day at 92.94 and then continuing to advance the rest of the week. Since 94 provided support on the way down it will likely now be resistance on the way back up. Since equities and crude oil have been following the currency markets further dollar advances would likely create headwinds.
Since May is typically a weak month for equities, the old adage “Sell in May” attracts a lot of attention. Here is the original English saying. “Sell in May and go away, don’t come back till St Leger Day” – a three day horse racing event in Doncaster, England starting this year on September 7. Since sector rotation, also called sector churn, when HFT traders push up one sector until there are no more buyers and then rotate into sectors where there are no more sellers, currently dominates the markets selling in May, or at least hedging some equity exposure could be prudent. Remembering the market adage “When in doubt, close it out” or perhaps, when in doubt begin to get out consider using?SPDR S&P 500 ETF (SPY) put spreads or ProShares UltraShort S&P 500 (SDS) call spreads like the ones?from last week.
Summary
Both the S&P 500 Index and the DJ Transportation Index recently closed below their key operative upward sloping trendlines but then held important lower support levels and may attempt to turn higher again, but valuation and seasonal history tips the scale to the advantage of the downside.