Late last week, the stock market seemed to lose its footing, as the Dow slipped from a 13-month high of 10,437. Options expert, Jay Shartsis, believes that last week’s stumbling stock market is a sign of things to come.
Meanwhile, our colleagues over at The 5-Minute Forecast argue that the stock market should never have been rallying in the first place. The economy still stinks, they say, and it is showing no signs of recovering. In fact, a close look at the housing market tells you all you need to know about the economy…and the news is not good.
Jay Shartsis, the mind behind the Shartsis Option Alert in New York observes:
The always-intriguing “Stock Cycles Forecast” is looking for an important top right in here. This bearish outlook stems from a quirky collection of indicators called “time and price squareouts.” For example:
1) The big S & P low in October of 2002 was 769. If one adds 769 days to the grand top of Oct 11, 2007, it comes out to Nov 18, 2009.
2) Nov 18, 2009 is a “natural square” of the crash of 1929.
3) The Oct 2002 low of 769 on the S&P 500, converted to months is 25 and due west from 25 on the Gann Square of Nine points to an S&P target of 1,104. We are there.
4) We are 85 months from the low recorded on Oct 10, 2002 and due West from 85 on the Gann Square is 1,105, which coincides with the same S&P 500 target.
5) The low last March on the S&P 500 was 666. If we subtract that in days from the recent peak of 1,102, it equals 666 days, which would bring us back to the date of the Lehman bankruptcy – the event that started the crash.
I know all this sounds very wacky and mystical, but Jenkins (the editor of Stock Cycles) has had some very good calls with this methodology in the past.
Another much less mystical indicator is the VIX Index of option volatilities – aka, the Fear Gauge. For starters, the VIX is currently sitting at its lowest levels since just before the stock market crash of one year ago. That’s a bearish indicator all by itself. But there’s more to the story. The January VIX futures contract is trading at a steep $4 premium to the spot VIX. Normally, a large premium in the near-term futures contracts relative to the spot VIX price would portend an imminent stock market selloff. The opposite is also true.
Thus, three weeks ago, as the S&P was hitting its recent low of 1,029, the VIX futures had a discount of $3 versus spot. Stocks promptly rallied. But today, we find the opposite configuration, which is quite bearish indeed.
A selloff is not guaranteed in here, but it is becoming an increasingly likely possibility.
for The Daily Reckoning Australia