Markets are on Fire

Last week's outlook was for an upward bias with the possibility of sharp reversals due to delta hedging and we certainly got that.  If you were lucky enough to read the Wed update before the close, the options setup pointed to a reversal to below SPX 4300 then a rally back to 4350-70 and the low Thur AM was 4289 with a close Fri at 4370.  I misread the CPI/PPI release dates next week and they are Tue/Wed for CPI/PPI not Mon/Tue so cancel Fri update.  Will try to do an update Mon an hour before the close.  Currently the Wed SPX options OI shows a similar setup where a gap fill at 4320 could occur Tue/Wed with a likely rally back to ATH by Fri close.  We may be setting up an expanding wedge pointing to lower 4200s by mid-Aug.  If int rates (TNX) stays below 1.5% that may be as low as we go for ST.

This week I am replacing the ST/INT options Smart/Dumb Money indicator with a hybrid INT/LT options/ETF indicator. This is based on the past few weeks of comparison of indicators compared to 2015 and this weeks options P/C analysis in the Tech/Other section.

The first installment of the Investment Diary update Data Mining Indicators - Summer 2021 is available, but only covers the new INT/LT Composite and ST Composite as well as the new INT/LT options/ETF indicator. .

I. Sentiment Indicators

The overall Indicator Scoreboard (INT term, outlook two to four months) bearish sentiment will be dropped next week to be replaced by more time sensitive (ST, ST/INT, INT/LT) and less dependent on distortions from P/C ratios (see Tech/Other) which comprise about 60% of the active overall sentiment.

The INT/LT Composite indicator (outlook 3 to 6+ months) has three separate components. 1st is the SPX and ETF put-call indicators (30%), 2nd the SPX 2X ETF INT ratio (40%), and 3rd a volatility indicator (30%) which combines the options volatility ratio of the ST SPX (VIX) to the ST VIX (VVIX) with the VXX $ volume.

This indicator has bounced back from the recent Sell levels but is warning of an INT top likely in the next 3 months.

The ST Composite as a ST (1-4 week) indicator includes the NYSE volume ratio indicator (NYDNV/NYUPV & NYDNV/NYDEC) and the VXX $ Vol/SPX Trend. Weights are 80%/20%.

The recent decline below SPX 4300 on Thur has pushed the ST Composite to a mildly positive position and is likely to elevate prices thru optn exp Fri before further pullback.

Bonds (TNX).  Bearish sentiment in bonds remains at low, but not extreme levels.  Next weeks CPi/PPI may test bond holders resolve if levels are as high as last month.

For the INT outlook with LT still negative, the gold miners (HUI) bearish sentiment is presented in a new format using the data mining software to add the inverse TNX rate to the ETF ratio.

Sentiment remains at low levels.  As pointed ot last the 240-60 level is likely to provide strong support as long as int rates (TNX) remain below 2% and strong bounce from 260ish was seen last week.

II. Dumb Money/Smart Money Indicators

This week I am replacing the option-based Dumb Money/Smart Money Indicator with a new hybrid option/ETF as a INT/LT term (outlook 2-6 mns) bearish sentiment indicator. In a large part this is based on the current option sentiment distortions discussed in the Tech/Other section. The use of ETFs increases the duration (term).  More thorough discussion and correlation with future returns is in the Investment Diary update.

This indicator is warning of an approaching INT top, having reached levels comparable to those seen before the last three INT tops.  Lead times can be 3-4 months as seen before the Jan 2018 and Mar 2020 tops, or as short as 1 month as in Sept 2018.

And the sister options Hedge Spread bearish sentiment as a ST/INT indicator (outlook 1-3 mns).  Hedging picked up last week with the increase in volatility and may support prices ST.

III. Options Open Interest

Using Thur closing OI, remember that further out time frames are more likely to change over time, and that closing prices are more likely to be effected. Delta hedging may occur as reinforcement, negative when put support is broken or positive when call resistance is exceeded.  This week I will look out thru July 16.

With Fri close at SPX 4370, options OI for Mon is very small with first level of call resistance at 4375 and put support at 4275.  Likely a tight range 4350-75.

Wed has somewhat larger OI where SPX has strong call resistance at 4350 and put support at 4325.  I had incorrectly reported this weeks CPI/PPI as Mon/Tue where it is actually Tue/Wed at 8:30AM EST so this is where delta hedging may reverse below 4350, possibly to fill The Fri gap at 4320.

For Fri strong put support at SPX 4300 and lesser at 4325 and only small call resistance at 4350 and above indicates a Wed BTFD for an optn exp rally back to 4375 or higher.

IV. Technical / Other

This week I wanted to take at the various Put/Call ratios from mid-2014 to today.  Previously, I used the period from mid-2014 to mid-2016 as a base period to set up the older indicators I was using, but recently since Mar 2020 they were not working as well. Previously I had shown that the ETF short/long ratios and volatility measures remained consistent, so today I want to look at the options starting with the Combined Put-Call Revised indicator (Equity + ETF + SPX).

As you can see below, the volume of puts and calls and the P/C ratio were in a similar range from late 2016 to late 2019 after a brief spike the 2nd half of 2015.  The avg P/C remained about 1.0.  After Mar 2020 something strange happened, however, and since then the avg P/C has dropped to 0.70.

Most would probably say that this was due to the equity options trading and you would be right.  Prior to Mar 2020, the equity P/C avg was about 0.65 and has since dropped to 0.45. The amazing thing is that since Dec 2015 the level of equity call volume has a very high correlation with the level of SPX prices.  If the SPX rises to 6000 as some are saying, does this mean the equity P/Cs will drop to 0.25?

The ETF options also saw a sharp drop in volume, however, and even more surprising the volatility of the ETF P/C has gone down by more than 50%.

The SPX options seem to be the only market that has maintained some semblance of normality. Other than mid-2016 to mid-2017, which saw a high level of puts and calls, the volume of calls has remained in a similar range while there has been a lower levels of puts which lowered the P/C ratio.  There also seems to be an increase in put volume prior to INT tops with current levels similar to May and Dec 2015, Dec 2017, and Sept 2018.

It's hard to tell the what reasons are for the changes since Mar 2020, possibility its just increased speculation as a combination of zero commission trading with a population that is tired of sitting around watching TV with excess of funds from gov't support from the pandemic?

Conclusions.   Speculation is rampant, but until someone yells "Fire" the party goes on.  The recent collapse of a Miami Surfside condo should provide a warning of what happens when a high rise or market is not built on a solid foundation.  Sentiment ST is pointing to continued upside momentum, while INT/LT sentiment is looking more and more worrisome.  Sleep with one eye open and have a parachute handy.

Weekly Trade Alert.  Weak options sentiment thru mid-week shows the potential for a move down to fill Fri opening gap at SPX 4320 by Wed, probably due to Tue/Wed CPI/PPI, while a more bullish outcome is possible by EOW.  Updates @mrktsignals.

Investment Diary,  Indicator Primer,
 update 2021.07.xx  Data Mining Indicators - Update, Summer 2021 (in progress),
 update 2020.02.07 Data Mining Indicators,
 update 2019.04.27 Stock Buybacks,
 update 2018.03.28 Dumb Money/Smart Money Indicators

Article Index 2019 by Topic, completed thru EOY 2020.02.04
Article Index 2018 by Topic
Article Index 2017 by Topic
Article Index 2016 by Topic

Long term forecasts

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