As the equity markets opened last week, the direction outlook was uncertain as they were poised to go in either direction. The answer came Tuesday as the S&P 500 Index (SPX) gapped higher on the open, closing convincingly above the previous high made on February 20 at 1530.94. Now with no overhead resistance, we expect it to continue advancing higher.
In the strategy section below, we have some additional details in support of our bullish outlook along with a few words of caution, followed by an update for United States Oil (USO).
Strategy
Two weeks ago, we said the correction could take the S&P 500 Index (SPX) back to 1480 or even back to the breakout around 1460. Since then the picture has changed, especially after it broke out of the symmetrical triangle continuation pattern last Tuesday. Ideally, the breakout should have been on higher volume, but then it advanced every day last week and the volume expanded somewhat by Friday. As a show of relative strength, the reversal low of 1485.01 made on February 26 is important since it means this pullback did not decline enough to test the active upward sloping trendline. Support is now at the February 20 high of 1530.94 while the only possible resistance is the old October 11, 2007 high of 1576.09.
While keeping in mind the 10% correction that began last April 3 on news reports the economy was slowing, be on the lookout for any key reversal made with increasing volume. It could indicate another attempt to test the upward sloping trendline since the economy could experience another slowdown this spring as sequester spending cuts gain momentum and possibly roll back the recent employment gains.
S&P 500 Index Implied Volatility (IVXM)
Last week the Implied Volatility Index Mean decreased from 12.50 to 10.22, while the CBOE Volatility Index? (VIX) decreased from 15.36 to 12.59.
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.
The day weighting applies 28% to March and 72% to April for an average premium of 16.87% shown above. Our alternative volume weighting between March and April is 14.23%. The premiums have returned to the normal range as the futures prices declined across the term structure last week.
iPath S&P 500 VIX Short Term Futures ETN (VXX)
The five-day average volume was 46.6 million shares down substantially from 84 million the week before as enthusiasm for VIX hedging waned.
VelocityShares Daily Inverse VIX Short Term ETN (XIV)
The 5-day average volume for the inverse was 15.5 million shares compared to 23.7 million the week before making the VXX/XIV ratio 3.00.
When the term structure is in contango, or it slopes upward over time, the advantage goes to a long XIV position since it represents a short futures position and VXX continuously sells the near term contract and buys the next longer term contract at a higher price. The current spread between March and April is -1.27 compared to the previous week when it was -.53.
United States Oil (USO)
Updating the suggestion we made last week, we now think the bottom has likely been made for USO since it is highly correlated to equities and it closed Friday above 33, the SU (stop/unwind) level we set in the most recent USO trade plan. Accordingly, we now suggest closing any remaining open bearish put spreads.