When Volatility Falls on a Down Day for the Stock Market

Breadth settled modestly positive Monday in very thin trading, keeping the
NYSE McClellan Oscillator in short-term overbought territory. Big board volume
hit its lowest level in over two months, as did volume in the exchange traded
funds SPY and QQQQ. Historically, a two-month low for QQQQ volume has usually
led to short-term weakness given the absence of institutional firepower. Out
of the last 30 separate instances in which QQQQ volume hit a two-month low, 26
led to a subsequently lower QQQQ close within the next few sessions...

QQQQ volume hits its lowest level in Forty Trading Days
11/03/08... ???
08/22/08... QQQQ lower close one day later
04/28/08... QQQQ lower close two days later
04/21/08... QQQQ lower close one day later
04/14/08... QQQQ no lower close within three days
04/08/08... QQQQ lower close one day later
12/24/07... QQQQ lower close two days later
11/23/07... QQQQ lower close one day later
10/08/07... QQQQ lower close three days later
10/02/07... QQQQ lower close one day later
07/03/07... QQQQ no lower close within three days
05/07/07... QQQQ lower close three days later
04/05/07... QQQQ lower close one day later
03/23/07... QQQQ lower close two days later
12/26/06... QQQQ no lower close within three days
11/24/06... QQQQ lower close one day later
08/31/06... QQQQ lower close three days later
07/03/06... QQQQ lower close one day later
05/08/06... QQQQ lower close one day later
03/27/06... QQQQ lower close one day later
11/25/05... QQQQ lower close one day later
11/14/05... QQQQ lower close one day later
09/12/05... QQQQ lower close one day later
08/19/05... QQQQ lower close two days later
05/27/05... QQQQ lower close one day later
11/26/04... QQQQ lower close one day later
10/11/04... QQQQ lower close one day later
08/26/04... QQQQ lower close two days later
04/12/04... QQQQ lower close one day later
11/28/03... QQQQ lower close three days later
08/15/03... QQQQ no lower close within three days

This setup has maintained a roughly 85% win rate (43/51) going back to 1999,
compared with 67% at-any-time odds of a lower QQQQ close within the next three
days.

The latest Purchasing Managers Index fell below the 40% level in October, the
first sub-40% reading we've seen since 1991. I've highlighted every instance
of a reading under 40% on this long-term chart. Note that the stock market has
typically priced in the recessionary environment prior to the actual sub-40
PMI. Whether that's true this time around remains to be seen, but I have my
doubts. The S&P is back in its long-term trendline channel, suggesting the SPX
1075 area represents long-term resistance. The 200-day moving average of up-
down volume remains decidedly negative. The Nasdaq/NYSE Volume Ratio is still
running in 'market topping' territory, a bearish sign from a longer-term
perspective. And the Last Hour indicator has only retraced about half of the
2005-2007 decline. From the standpoint of those last two indicators in
particular, there's definitely room for lower prices over the long-term.

Interesting to note the sharp 10%+ drop in the volatility indexes (VIX, VXO)
on Monday. That's a fairly steep decline considering the S&P actually closed
lower on the session. Typically a drop of over 5% for the VXO coincides with a
rallying market. When the S&P has failed to rally on a day when the VXO has
fallen over 5%, it's typically been a sign of 'heavy' conditions short-term.
Since 1994, this setup has led to a lower S&P close the following session 62%
of the time, compared with 47% at-any-time odds of a lower SPX close the next
day. That's not quite enough of an edge to qualify for inclusion on the board,
but it does reinforce the market's short-term vulnerability...

VXO -5% and S&P500 Closes Lower
11/03/08... S&P500 ??? next day
07/21/08... S&P500 +1.3% next day
01/18/08... S&P500 -1.1% next day
12/19/07... S&P500 +0.5% next day
08/20/07... S&P500 +0.1% next day
08/13/07... S&P500 -1.8% next day
12/15/05... S&P500 -0.3% next day
04/08/03... S&P500 -1.4% next day
09/18/01... S&P500 -1.6% next day
07/20/01... S&P500 -1.6% next day
07/05/01... S&P500 -2.4% next day
06/29/00... S&P500 +0.9% next day
01/21/00... S&P500 -2.8% next day
01/03/00... S&P500 -3.8% next day
10/14/99... S&P500 -2.8% next day
04/15/99... S&P500 -0.3% next day
04/28/98... S&P500 +0.9% next day
09/05/97... S&P500 +0.2% next day
02/21/97... S&P500 +1.1% next day
07/24/96... S&P500 +0.7% next day
05/03/96... S&P500 -0.1% next day
10/06/95... S&P500 -0.7% next day
06/23/95... S&P500 -1.0% next day
06/09/95... S&P500 +0.6% next day
10/31/94... S&P500 -0.8% next day
10/05/94... S&P500 -0.3% next day
09/02/94... S&P500 +0.2% next day

Bill Luby over at VIX & More had an interesting column Monday pointing out the
relatively low VIX (implied volatility) readings compared to the S&P's 30-day
historical volatility. I tend to agree with Bill and Adam that the market's
looking a little complacent, a dangerous condition given that volatility
remains sky high. While the intermediate-term outlook remains constructive,
there's downside risk short-term.

Categories : Archived EOD Commentary, End-of-Day Commentary

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