Bearish Divergence Resolved Into A Volatility Surge – Above the 40 (January 27, 2021)

Stock Market Commentary

The recent bearish divergence in the stock market resolved to the downside in a big way. Breakdowns rippled throughout the stock market even as numerous micro-bubbles soared in the opposite direction. A volatility surge clarified the new bearish turn in sentiment.

In the “background”, the Federal Reserve rolled out its latest pronouncement on monetary policy. Chair Jerome Powell announced no changes, and the press conference was barely newsworthy (in a future post, I will discuss Powell’s commentary on whether monetary policy is contributing to bubbles in the stock market). Investors and traders were left wondering whether a top finally arrived. Given this selling comes on the heels of days and days of weakening overbought conditions, I strongly suspect that, at a minimum, the upward momentum is over for some time.

The Stock Market Indices

The S&P 500 (SPY) broke down below its uptrending 20-day moving average with a 2.4% loss. The move triggered my condition for bearishness, so I added more SPY put spreads to the books; the new ones expire in two Fridays. Next stop should be the uptrending 50DMA (red line below). A fresh close above the 20DMA will likely close down bearish vibes all over again (no need to wait for a new all-time high for that signal).

The S&P 500 (SPY) gained 0.9% and stretched for an all-time high.
The S&P 500 (SPY) dropped 2.4% and sliced through uptrending 20DMA support.

The NASDAQ (COMPQX) also suffered heavy selling but avoided a 20DMA breakdown. The tech laden index lost 2.6%. Big cap tech earnings this week will help determine whether the NADSAQ quickly joins the S&P 500 in short-term bearish territory.

The NASDAQ (COMPQX) gained 0.7% to end a week the strung together a series of all-time highs.
The NASDAQ (COMPQX) stopped short of 20DMA support with a 2.6% loss.


The iShares Trust Russell 2000 Index ETF (IWM) also avoided a 20DMA breakdown. IWM perfectly tested 20DMA support after a 1.8% loss. I believe surges in micro-bubbles helped support IWM.

iShares Trust Russell 2000 Index ETF (IWM) resolved its recent churn with a sharp test of 20DMA support.

The Select Sector SPDR Trust Financial (XLF) rallied sharply into the earnings reports of major financial institutions. The ETF has weakened ever since and led the way in growing bearish signals for the stock market. XLF opened the week with a 20DMA breakdown. Today, it cracked 50DMA support with a 3.0% loss. XLF’s early 2021 breakout came to an end.

Select Sector SPDR Trust Financial (XLF) broke through 50DMA support

Stock Market Volatility

The faders in the volatility index (VIX) completely disappeared. The VIX closed at its high of the day with a whopping 61.6% gain that would make a micro-bubble stock proud. Still, the VIX stopped short of its last major peak. I sold my UVXY call options into this surge; I continue to hold UVXY shares (up 31.5% on the day).

The volatility index (VIX) continues to cling to the 20 threshold.
The volatility index (VIX) is banging on the floor of support again.

The Short-Term Trading Call: Bearish Divergence Resolved to the Downside

  • AT40 = 46.2% of stocks are trading above their respective 40-day moving averages
  • AT200 = 86.6% of stocks are trading above their respective 200-day moving averages (TradingView’s calculation).
  • Short-term Trading Call: cautiously bearish

AT40 (T2108), the percentage of stocks trading above their respective 40DMAs, plunged from 63.5% to 46.2%. Bearish divergence resolved with an exclamation point thanks to its extreme move. Given the S&P 500’s breakdown, I flipped the trading call to (cautiously) bearish as planned. I did not downgrade to fully bearish because the extreme surge in the VIX is not sustainable. While sellers may be able to squeeze a little more juice out the VIX, sudden bursts of fear in the market tend to attract volatility faders and contrary buyers. The prospects of a quick snapback prevent me from getting fully bearish. Moreover, at the current pace, AT40 could soon get “close enough” to the oversold threshold of 20%.

In other words, I am bracing for churn in the outlook for sentiment in the stock market. The upward momentum is likely over but the path downward likely already experienced its swiftest moment…at least until the VIX cools off and forms a fresh launching pad…

Stock Chart Reviews – Below the 50DMA

CBOE Global Markets Inc (CBOE)

With all the frenetic trading going on in the stock market, especially in stock options, I was surprised to notice the on-going struggles of CBOE Global Markets Inc (CBOE). CBOE was supposed to be a good trade on increased volatility in the stock market. I accumulated shares but eventually gave up on the stock. CBOE experienced a relatively weak rebound from the March stock market crash and topped out quickly. CBOE finally pulled off a 200DMA breakout last month and enjoyed a brief run. It sold off along with other financials from there. Today, CBOE lost 4.4% and closed below converged support at its 50 and 200DMAs. The setup for a buy is tempting, but I am deferring to my short-term bearish trading call on this one.

CBOE Global Markets (CBOE) finished erasing its last breakout with a 50DMA breakdown.

CME Group (CME)

CME Group (CME) is similar to CBOE. This is a stock I expected to do much better in a frenetic trading environment. CME managed a 200DMA breakout in November and spiked to a new post-crash high before joining financials in a sell-off. The day’s 2.7% loss completed the reversal of gains from the January 6th breakout. Perhaps a successful test of 20DMA support might coincide with a bullish signal from AT40.

CME Group (CME) has suffered near non-stop selling pressure since its last peak.

CSX Corp (CSX)

Last summer, I expressed interest in buying railroad company CSX Corp (CSX). I was in the early stages of turning my attention to industrial plays. I never pulled the trigger. So when the stock dropped post-earnings, I went ahead and took the leap with a covered call position. The selling continues with the October breakout in danger of a full reversal. At this rate, CSX could easily test 200DMA support. If not for my commitment to this position for a longer time period, CSX would be on my list of potential shorts.

Post-earnings selling pressure continues for CSX Corp (CSX) on a confirmed 50DMA breakdown.

Stock Chart Reviews – Above the 50DMA

Netflix (NFLX)

I was surprised to see Netflix (NFLX) join the flood of selling. The 6.9% loss continues a big post-earnings fade. NFLX gained 16.9% after releasing earnings and finally broke out to a new all-time high. As a result, I assumed NFLX regained bullish momentum. Instead, sellers took over from there. The post-earnings gap even looks in danger. If NFLX continues with a 200DMA breakdown, the stock goes back on my bear list.

Netflix (NFLX) plunged right back into its former trading range as post-earnings momentum lasted just a day.

Vir Biotechnology (VIR)

This stock is a huge miss. I identified Vir Biotechnology (VIR) as a buy on dips back in June. At the time, the stock had cooled off from a brief and sharp speculative run. I was looking for a dip to buy. The dip never quite arrived. However, VIR spent the last two months or so consolidating after its last earnings report. A 50DMA and then a 200DMA breakout this month provided buy signals. By then, VIR slipped off my radar…until now.

Somehow, VIR made it all the way to $141 before fading back to a 7.4% gain on the day. The company announced results from a Phase One trial of VIR-3434 for chronic hepatitis B Virus, but received a downgrade from JP Morgan (JPM) for its efforts. JPM slapped a $30 price target on VIR and underweight rating.

Given the environment of micro-bubbles, I habitually check short interest on stocks that suddenly launch into the stratosphere. Sure enough, as of December 31st, VIR has 20.8% of its float sold short. I am keeping better track of VIR now.

Vir Biotechnology (VIR) increased as much as 82.2% before settling down. VIR is still up 128% since its 200DMA breakout.

U.S. Concrete (USCR)

In my last Above the 40 post, I worried about the breakdowns in the materials and industrial ETFs. U.S. Concrete (USCR) is one of several related victims. USCR dropped 4.9% and almost touched 50DMA support at its low of the day. USCR has almost completely reversed its gains since the day liquidity triumphed over political unrest and instability. I am a permabull in USCR after interviewing the former CEO thrice in the past. As a result, when I see a technical setup for a buy, I get on near automatic. Given my bearish trading call, I will wait for a confirmation of 50DMA support before buying (USCR has to close above today’s intraday high of $42.40). At 200DMA support, I buy automatically unless the plunge comes from something company-specific.

U.S. Concrete (USCR) is rushing for a test of 50DMA support.

Be careful out there!

Footnotes

“Above the 40” (AT40) uses the percentage of stocks trading above their respective 40-day moving averages (DMAs) to measure breadth in he stock market. Breadth indicates the distribution of participation in a rally or sell-off. As a result, AT40 can identify extremes in market sentiment that are likely to reverse. Above the 40 is my alternative name for “T2108” which was created by Worden. Learn more about T2108 on my T2108 Resource Page. AT200, or T2107, measures the percentage of stocks trading above their respective 200DMAs.

Active AT40 (T2108) periods: Day #73 over 20%, Day #57 above 30%, Day #56 over 40%, Day #1 under 50% (underperiod ending 54 days over 50% and 53 days over 60%), Day #1 under 60%, Day #4 under 70%

Black line: AT40 (T2108) (% measured on the right)
Red line: Overbought threshold (70%); Blue line: Oversold threshold (20%). Source: FreestockCharts
Percentage of stocks trading above their respective 200-day moving averages (DMAs) according to TradingView.com (MMTH)

Source for charts unless otherwise noted: TradingView.com

Full disclosure: long UVXY shares, long SPY put spreads, long CSX covered call position

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*Charting notes: FreeStockCharts stock prices are not adjusted for dividends. TradingView.com charts for currencies use Tokyo time as the start of the forex trading day.

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