The market, as measured by the S&P 500 index, was under a lot of pressure last week, but managed to reverse and stage a rally into the end of the quarter. Was this just “window dressing,” or have the bears lost the control that they’ve had since first few days of September?

The market
SPX,
+1.39%

is in a stair-step pattern lower. This is a relatively orderly decline, compared to the “smashes,” if not “crashes,” of February 2018, October 2018, December 2018 and March 2020.

In the first stage, the S&P broke support at 3,420 and then later rallied strongly to test the resistance at that level, which held. After that, the index broke support at 3,310-3,330, but then rallied back to test resistance at that level, and it held also. Then, when the S&P broke what we deemed the last important bullish support at 3280, that seemingly put the bears in charge.

However, a minor oversold condition sparked a huge rally in the S&P and its futures as the end of the third quarter approached. Not only did it bounce hard off of 3,210-3,230 (so that is now support), but it climbed all the way back above 3,330.

So we are now in a bit of trading range once again. On the top, there is the resistance at 3,425. A close above there would be a victory for the bulls. On the downside, though, a close back below 3,300 (which would fill the gap from Sept. 28) would return command to the bears. In between, it seems we have a volatile trading range, as evidenced by the 70-point decline and then complete recovery and more, all in a mere 12 hours or so after the presidential debate had ended.

The McMillan Volatility Band (MVB) sell signal has essentially fulfilled its target. It did so when the S&P 500 closed below the -3σ Band on Sept. 23. A new buy signal is not in the process of setting up, though. The index would have to close below the -4σ Band in order to do that.

Equity-only put-call ratios remain solidly on sell signals, as they continue to rise out of the massive, multiyear overbought conditions that existed at the beginning of September. They will remain bearish until they roll over and begin to trend downward. While put buying is increasing, there is still plenty of call buying, too. Hence, the sort of extremely high daily put-call ratios that we often see near market bottoms have not yet occurred.

Market breadth had deteriorated badly into the Sept. 24 lows, and the breadth oscillators were in an extremely oversold state. Since then, with the S&P rallying strongly on two days, the breadth oscillators have generated buy signals. Those remain in place now. Just as a side note: Sept. 23 was a “90% down day” — the first such day we’ve had during this decline.

For a few days new lows edged ahead of new highs, but not by enough in NYSE terms to generate a sell signal. We wanted to see more new lows rather than just a decrease in new highs in order to trigger a sell signal here. That did not happen.

Volatility indicators remain in the bullish camp for stocks, under the strict interpretation of their statistical measures. However, the distortion in the volatility space being created by the “volatility bubble” in the S&P’s options prices for November and, now, December too has distorted things enough that a strict interpretation may be missing the point. For example, the VIX “spike peak” buy signal of Sept. 4 remains in effect. That is, VIX has not risen at least 3.00 points over any three-day period since then (using closing prices).

This means that the S&P 500 had declined by 380 points at its lows (and is still down substantially), and VIX
VIX,
-3.61%

  has not risen three points in any three-day period! That is unfathomable in the “strict” world, but in this election-distorted world, it is reality.

Our other VIX indicator is its trend. We determine that by simply stating that if VIX and its 20-day moving average are on the same side of the 200-day moving average, the trend is in place. For most of the S&P’s decline this month, VIX and its 20-day moving average have been below the VIX’s still-rising 200-day moving average.

In strictly normal times, that would be bullish for stocks, as it would indicate a downtrend in VIX (and, by implication, an uptrend in the S&P). But in the current market, VIX is not moving opposite to the S&P so that “strict” relationship is no longer in place. Both VIX and its 20-day moving average are currently below the 200-day average, so they remain bullish as far as stocks are concerned.

The construct of volatility derivatives shows the current distortion in volatility better than anything else. October (front-month) VIX futures continue to trade with a healthy premium to VIX. Now, November VIX futures have exceeded October in price (meaning that the SPX options expiring in December of this year are now trading with higher implied volatilities than those of November — indicating that post-election problems might extend out toward the end of the year). From there, the term structure slopes downward, but the whole thing is biased by that volatility “bubble” in post-election S&P options.

In summary, the S&P 500 chart is a negative one with a pattern of lower highs and lower lows. But the Index is now in a volatile trading range between 3,300 and 3,425. A breakout in either direction should find some follow-through. Meanwhile, we will trade signals in either direction when they are confirmed, but not before.

Lawrence G. McMillan is president of McMillan Analysis, a registered investment and commodity trading advisor. He may hold positions in securities recommended in this report, both personally and in client accounts.

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