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The big indexes are trading at just about the same levels they were three weeks ago.
My experience tells me this means the market is at a tipping point as it searches for an ultimate direction. Seasonality and sector rotation are in play right now – as I’ve been saying for the past few weeks.
Change is in the air; market leadership is changing hands.
My job is to make sure you’re on the right side – now, and when the “flip” happens…
This Bullish Old Standby Seems to Be Running Out of Gas
Small caps, as tracked by the iShares Russell 2000 ETF (NYSE Arca: IWM), are struggling. That’s significant as we previously cited small-cap outperformance as an indicator of the bullish risk-on trade being in force. But that “on” is now in jeopardy…
The chart below shows that the IWM is in the process of posting the third in a series of lower highs since early July.
The bottom line: IWM needs to move above $170, its record high, to break this downward pattern and confirm that the risk-on trade is still potentially in play.
Here’s another indication that the market’s zest for risk is fading. IWM’s 50-day moving average has begun to “roll over” into an intermediate-term bearish trend.
The last time this happened was in February, when the market was heading into its last spate of volatility.
Out in the broader markets, though, there are two specific indicators that could ultimately decide which way the market goes…
These Numbers Are Mixed – Here’s Where We’re Headed
First, there’s the 2,800 level of the S&P 500. Besides serving as round-numbered support, 2,800 was also the approximate site of peaks in February, March, and June.
Also, its 50-day moving average is rapidly rising to this level; it’s currently at 2,792. The last time the S&P broke below its up-trending 50-day moving average was in mid-March, just as the index was beginning a 7% plunge to its 200-day moving average.
On Thursday, the SPX bottomed at 2,802, further proof that it’s an important support level. And that stance is certainly bolstered by Friday’s broad-market surge, which saw it top 2,842.
But there are plenty of sellers waiting for such a positive move, and I expect these sellers to test the market’s strength, which could cause stocks to struggle next week.
The second indicator is the CBOE Volatility Index – the VIX. It’s just had a busy week. On Wednesday, it surged 27% to crest just shy of 17.
Ultimately, it closed below 15 on Wednesday and fell the rest of the week, to under 13.5 at midday Friday. Staying below 16 on a closing basis is crucial to maintaining upward momentum.
On the other hand, any sustained move above this level could bring a sharp reversal in the market.
Right now, in my research services, I’ve recommended a balance of bullish and bearish plays, calls and puts – to reflect the uneasy balance of the current market. It’s the safest, most profitable way forward right now.
In fact, my readers had the chance to take down a 19% gain on some calls… and a 107% on half of a big put position.
The bottom line is this: For the short-term, I think every investor can expect that balance to continue, but it makes increasingly more sense to prepare for a move lower, sooner rather than later.
Remember, we’re heading into what is historically one of the most volatile two-month periods of the year.
Currently, the portfolio has three calls and three puts. As things stand, we should expect that balance to continue with a slight bias toward puts on concerns over the continued deterioration among some market-timing indicators as we head through one of the most volatile two-month periods of the year.
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