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MONDAY a.m.
August 4, 2003



VIX Popping
by David Nichols

At last, something different happened in the markets during the decline at the end of last week -- the Volatility Index (VIX) actually jumped up significantly.



This shows that a real hint of fear actually managed to worm its way into the minds of market participants. The late Thursday meltdown, followed by Friday's continuation off the employment report, has turned the momentum of sentiment to rising fear. Importantly, the weekly VIX has now put up a white weekly "engulfing" candle -- meaning the closing level on the VIX was higher than the opening level, and it climbed to levels higher than the previous week. It engulfed the prior action.



These white weekly engulfing candles from the low 20s on the VIX have been really great sell signals over the years -- even during the bull market of the 90s. The last such candle came on the spike to the top on June 6th -- which coincided with June's employment report, in fact -- and even though the market hasn't immediately fallen off a cliff, it hasn't made any upside headway either, and has now fallen back from that level.

During the last three years of the bear market, such white weekly engulfing candles on the VIX from these levels down in the low 20s have been unbelievably profitable shorting opportunities. Staggeringly profitable, in fact. These initial bouts of fear turned into panicky, epidemic waves of selling, sending the VIX soaring.

I know, I know -- this time "it's different". It always feels different "this time".

But one thing really perpetuating this "different feeling" is the market has been able to shrug off these little bouts of fear and keep these spikes in the VIX as temporary events. The market has consistently found support around the 970 to 975 level on the S&P 500. There hasn't really been a cascade of supply for sale to crash the market through this level. The few "fear viruses" that have been unleashed have proven to be weak and attenuated, and haven't started any real selling epidemics.

This is now a much more fertile set-up for such a selling epidemic to proliferate. The SPX has fallen in price since the last volatility spike, and now we've just seen a second one. The speed of the decline from over SPX 1000 on Thursday afternoon down to Friday's close at 978 also argues that a bigger washout could now be in the works.

But this is an instance where we don't have to be too reactive, as "we'll know it when we see it". If and when the SPX blows down through 970 and the VIX simultaneously pops up through the top of its range -- above 24.50, let's say -- then we'll know that something really different is in the works.

However, it's still entirely possible -- even likely -- that the market will stage some sort of tepid bounce here at support first, sending the VIX back down a notch or two. So we'll need to pay close attention to this bounce. If the VIX plummets from here and price can barely budge back up, then the cascade down through support will be close at hand.

Yet some favorable news flow can once again easily squelch this budding fear virus too, and the summer flat spell can continue, with more tight drifty action to fool and frustrate the trend-chasers of the world. There are many more such traders now than there used to be, that's for sure, which goes a long way towards explaining the current lack of trend. The always-frustrating market needs to frustrate this group too.

Sentiment Dashboard
by Adam Oliensis



SENTIMENT TANK: Filled by 9 points to 13% full of negative sentiment. We have a longer-term view of the tank than normal today, dating back to Jan. 30, just so we can put all the recent action into perspective. The tank remains below the upper limit of the recent line of declining tops (black), but is now threatening that line.

SHORT-TERM: Hourly momentum is in a strengthening decline phase. However the momentum is as extended as it has been since the March low. So this market should either head into an hourly advance phase today or else do a much more serious swoon.

MID-TERM: Progressed 1 point to 63% in its advance phase with a low confidence reading of 1. If the market swoons from here this gauge will roll over pretty quickly.

LONG-TERM: Moved from a neutral reading, progressing 1 point to the decline side of the gauge but with a still-neutral confidence reading of 0. Making noises like it wants to start a more serious decline phase, but so far it's just rumblings.

BOTTOM-LINE: Sentiment has peaked over the edge of the precipice (as discussed in Sunday's Closing Bell) and is at a key turning point. The tank will either break its recent line of declining tops and head higher (likely sending the market down) or that line will hold and the SPX will bounce up within its recent pinch. If the line holds, that's just continuation of the consolidation. If the line breaks, the selloff could get sort of ugly. So, the risk/reward picture is probably skewed to the downside.