At a pretty important juncture…
Commentary: Volatility shot through the roof this week, as measured by the iPath S&P 500 VIX Short-Term Futures ETN (NYSE:VXX), which tracks the CBOE S&P Volatility Index. This index measures investor sentiment based on implied volatility for the S&P 500 and is commonly used as a “fear” index. With VXX surging over 10% this week, it shows fear flooding back into the marketplace. In response, market indexes suffered a string of losses this week, shedding most of their recent gains.
The chart for the S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, took a major hit this week as well, severing support levels near $107. SPY also fell beneath its rising 50-day moving average, and in fact closed the week below this level despite a sharp bounce from this area on Thursday. Volume has increased on this pullback and there has been a notable change in character in the markets. The steepness of the sell off, combined with the VIX rising, shows some panic in the markets. While it seems like the markets are broken at this point, it is important to keep the larger picture in mind. The key level to watch continues to be October lows near $102. This could still simply be a pullback within an uptrend.
The Diamonds Trust, Series 1 (NYSE:DIA) ETF, which tracks the Dow Jones Industrial Average, shows a very similar pattern to SPY. The volume on the recent decline is well above average, but DIA remains above its October low, and is even above its rising 50-day moving average. DIA, much like SPY, is still technically in an uptrend, but the action in other markets is flashing warning signs that all is not right in the markets.
The iShares Russell 2000 Index (NYSE:IWM) ETF is the first index to break a major technical level. IWM has been lagging its larger cap peers for several weeks, and didn’t run to new highs the past few weeks along with SPY and DIA. This week it suffered a steep decline and severed its October lows. This set a lower low, and also confirmed a double top reversal pattern in the small cap sector. The measured target for this reversal is near $52, which would have IWM testing the July breakout level. IWM is often looked to as a leader, as it shows the appetite for risk prevalent in the market place. If investors are shying away from small caps, it often shows a fear of putting money to work, and a rotation into safer assets. This action is often associated with declines in the markets.
The Powershares QQQ ETF (Nasdaq:QQQQ) is another group showing relative weakness to the large caps, although it is not quite as weak as IWM. QQQQ closed the week under its 50-day moving average and also broke under a trendline marking the last three recent pivot lows. While a trendline break doesn’t always signal a reversal, it does show that the market is unable to sustain the current rate of ascent, and is a valuable warning sign. The October low is the key area to watch here, as QQQQ is threatening to top out much like IWM. A move below this level, especially on a closing basis, would suggest much lower prices in the intermediate term. (For more, see Track Stock Prices With Trendlines.)
While all has not been lost for the major indexes, this week’s price action should not be ignored. There have been signals of weakness for several weeks now, and it appears that at least one market has broken down already. With the breakdown coming in a group that should be leading the way, caution is warranted at this point. The last three days in the markets have been very wide in range, and volatile too. This makes for an emotional environment, and it is often best to step aside at times like this and wait for a lower risk environment. The markets are quickly becoming oversold and approaching what should be strong support levels, so it may be that a snapback is soon to come. The key will be how the markets react to the next bounce, and whether that bounce will be used as a launching point for another down draft. The October lows remain the line in the sand for now, and will be pivotal in the coming week.