A New COVID-19 Variant and A New Normal – The Market Breadth

Stock Market Commentary

News of a new 30-spike protein COVID-19 variant sent financial markets into a tumble. The rapid news flow combined with a shortened, holiday trading day to deliver broad-based and intense selling pressure. As the market absorbs this latest blow, it should become clearer that COVID-19 is a new normal. That is, the need to accommodate the virus in every day life is here to stay for quite some time. On the whole, those who take the appropriate health measures will increase their odds of thriving over the long run of this new normal. Unfortunately, those who do not adjust to the new normal will carry heavier burdens (or cause them). The same principles apply in this stock market. This new normal means that the economy and financial markets carry higher risks even when all seems well. The market will reward speculation less and less.

The Stock Market Indices

The S&P 500 (SPY) was blithely churning at or near its all-time high for almost 3 weeks even in the face of declining market breadth. That relative quiet came to a resounding end with today’s 2.3% loss. November’s gains are suddenly all gone. If not for the close right at the lower Bollinger Band (BB), I would have anticipated an imminent test of support at the 50-day moving average (DMA). Instead, the lower BB could act at least as a brake for downward momentum.

The S&P 500 (SPY) broke out above its 50DMA and likely brought the bearish cycle to an end.
The S&P 500 (SPY) fell 2.3% and closed flat for the month of November. The close on the lower Bollinger Band (BB) should slow the path to a test of 50DMA support.

The NASDAQ (COMPQX) looks like a more volatile version of the S&P 500. The recent churn had an upward bias. The tech-laden index also delivered a much clearer reversal from the all-time high on November 22nd. The NASDAQ’s 2.2% loss, the test of the lower BB, and the complete reversal of November’s gains all mirror the S&P 500’s one-day decline.

The NASDAQ (COMPQX) gained 0.7% to end a week the strung together a series of all-time highs.
Like the S&P 500, the NASDAQ (COMPQX) lost 2.2% and closed flat for the month of November. The tap on the lower BB should also slow the NASDAQ’s path to a 50DMA test.

The new normal is the old normal for the iShares Russell 2000 ETF (IWM). Last week’s completed reversal of the November breakout proved fatal. IWM is now right back to the middle of the old trading range. The breakout is a distant memory. IWM lost 3.8% but, unlike the S&P 500 and the NASDAQ, buyers took the index well off its intraday low. Without the preceding trading range, the double breakdown below support at the 50DMA and 200DMA would look extremely bearish.

The iShares Russell 2000 ETF (IWM) lost 3.8% on a double breakdown below its 50DMA and 200DMA. Buyers saved IWM from a 5.2% loss at the lows.

The Financial Select Sector SPDR Fund (XLF) looks like the worst of all these indices. For the second week in a row, XLF suffered a 50DMA breakdown at the end of the week. XLF lost 3.3% and closed at a 6-week low. XLF looks topped out.

The Financial Select Sector SPDR Fund (XLF) closed a second straight week with a 50DMA breakdown. With the October breakout fully reversed, XLF looks topped out.


Stock Market Volatility

The volatility index (VIX) surged 54.1%. By this time, readers should already anticipate what comes next. Traders and investors have all weekend to shop for “bargains”, catch their collective breath, and, most importantly, find the positives sprouting through the negative COVID-19 variant headlines. In others, next week should feature the classic VIX fade from an extreme spike higher. Accordingly, I bought some shares in ProShares Short VIX Short-Term Futures ETF (SVXY) for a trade. This trade is NOT a bullish call. Rather, it is the acknowledgement of a consistent short-term pattern. Needless to say, I will be quite surprised if the VIX manages to push much higher from current levels. Hopefully, such a surprise also delivers the oversold levels that would flip me bullish on the stock market.

A rounded bottom for the volatility index (VIX) could be setting up a major surge in the coming weeks.
The volatility index (VIX) soared to an 8+ month high on a 54.1% gain.

The Short-Term Trading Call In the New Normal

  • AT50 (MMFI) = 37.7% of stocks are trading above their respective 50-day moving averages
  • AT200 (MMTH) 43.7% of stocks are trading above their respective 200-day moving averages (14-month low)
  • Short-term Trading Call: neutral

AT50 (MMFI), the percentage of stocks trading above their respective 50DMAs, fell as low as 33.5% before closing at 37.7%. This drop is “close enough” to oversold in a bull market. The odds further favor an imminent bounce given the extreme in the VIX. However, keeping with the theme of the new normal, I do not expect a rebound, whenever it happens, to carry the S&P 500 right back to its carefree uptrend around its 20DMA. Instead, I anticipate a lot of churn including false moves that frustrate bears and bulls alike. Accordingly, I am comfortable leaving the short-term trading call at neutral for now.

I now warily eye AT200, the percentage of stocks trading above their respective 200DMAs. Like IWM, the new normal for AT200 is the old normal. This longer-term indicator of market breadth closed at a 14-month low and looks set to resume its 2021 downtrend. This indicator is slow moving, so it does not trigger immediate trading action. However, AT200’s behavior reinforces the need to lower expectations in the new normal.

The climactic end to this week is a handy reminder of the power of technical signals. They do not predict outcomes in the way of a forecast, but they describe the conditions which can enable either good or bad news to exact directional force on the stock market. Here is a handy review of the warnings I issued about weakening market breadth and deteriorating technical conditions:

And, yes, I turned right around and bought a weekly call per the Apple Trading Model (ATM) strategy.

AT50 (MMFI) last closed this low in the final days of the September sell-off in the stock market.
AT200 (MMTH) plunged to its lowest close in 14 months. The 2021 downtrend looks set to resume.

Be careful out there!

Footnotes

“Above the 50” (AT50) uses the percentage of stocks trading above their respective 50-day moving averages (DMAs) to measure breadth in the stock market. Breadth defines the distribution of participation in a rally or sell-off. As a result, AT50 identifies extremes in market sentiment that are likely to reverse. Above the 50 is my alternative name for “MMFI” which is a symbol TradingView.com and other chart vendors use for this breadth indicator. Learn more about AT50 on my Market Breadth Resource Page. AT200, or MMTH, measures the percentage of stocks trading above their respective 200DMAs.

Active AT50 (MMFI) periods: Day #407 over 21%, Day #70 over 31% (overperiod), Day #1 under 40% (underperiod ending 41 days over 41%), Day #5 under 51%, Day #7 under 60%, Day #187 under 72%

Source for charts unless otherwise noted: TradingView.com

Full disclosure: long SVXY, long AAPL call

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*Charting notes: Stock prices are not adjusted for dividends. Candlestick charts use hollow bodies: open candles indicate a close higher than the open, filled candles indicate an open higher than the close.

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