On Friday, the DOW dumped over 900 points on news of a new virus variant in South Africa. It’s not known if it is really any worse than any of the others for those that get it and there have been no reasons given yet to think it is. I know there are people fearmongering this, but this is a quote from the WSJ talking with the South African doctor who has examined the variant more than anyone else – “He said that there were no indications so far that Omicron led to more severe illness than infections from other variants and that the current crop of Covid-19 vaccines should still shield people from serious illness and death.” In the end, though, when it comes to the markets, this news item doesn’t change my view of anything, because my views are really based on the overall trends and charts. I got good news and bad news for the markets when it comes to them.
First, take a look at the Russell 2000. On one hand, the whole big breakout that began in mid-October now looks like a false breakout as it collapsed back down below 35000. The good news, however, is that the IWM ETF, which tracks it, is now oversold in terms of its daily stochastics, which are below 20 now, so it is likely to at least bounce from here.
More importantly, for a timing perspective, the VIX surged over 50% on Friday and got up to 28. This is the “fear indicator,” which tracks the premiums people pay in the options market for volatility. It tends to go up when some people decide to scramble and buy puts to hedge their positions. Big percentage daily moves in the spike tend to coincide with short-term bottoms in the market. As you can see from this chart, all the VIX spikes were bottoms in the market this year.
This VIX spike means that the market is likely to start to rally before the end of this week, if not on Monday.
And this big of a spike means that there was enough fear generated last week that the stock market is likely to trend up to sideways for the rest of this year.
However, that doesn’t say anything about next year.
And I think we can find things to worry about for 2022.
For one thing, stage three tops tend to be characterized by false breakouts and that is just what the Russell 2000 did.
Secondly, the internals in the market continue to fade. Last week marked a new low for the percentage of stocks trading on the NYSE that are below their 200-day moving averages for the year.
In all the past major stage three tops in the stock market since 1999 this indicator would fall down to 50 and then bounce back into the 60-70 area on one final market rally before the final drop into a full blown stage four bear market.
What is more, we have seen what appears to be a secular bottom in the yields for corporate bonds in recent weeks, as I wrote about last week. If that is the case higher yields at some point are likely to hurt the stock market later next year.
What I’m going to be most interested in seeing for the rest of this year is not so much what happens with the stock market, but what the JNK high yield junk bond ETF does. It broke down last week and closed on Friday below its 200-day moving average. It appears to have just completed a stage three top.
If this ETF rallies from here and that rally stalls out below $108 that would complete its transition into a full blown stage four bear market. If that happens it would lead the stock market down next year.
In sum, there was extreme fear generated in the stock market on Friday – the type of which should enable the bulls to generate a rally into the end of the year, but it could easily end up being the last rally of this cyclical bull market that began after the stock market crash of last year.
If you are new to concepts such as a stage analysis they are critical for navigating the markets at turning points. I explain them in my book Strategic Stock Trading.
-Mike
