Why August Could be One Bear of a Month

Since my last blog post, titled “What I’m Seeing That Has Me Concerned About the Volatility Index” we saw a near 50% rise in the Volatility Index ($VIX) intraday nine days later on June 29th, which caught quite a few traders off-guard. I shared my insight that day in a piece for CNBC, saying the spike in volatility would likely be short-lived. Since then, volatility has resumed its downward path, hitting levels that have rarely, if ever, been seen (depending on which measure of volatility you use). In my VIX post I shared a chart of volatility seasonality, which showed that historically the VIX has put in a low around July/August. To expand on the topic of seasonality I want to dive into equity seasonality for August.

Below we take a look at different viewpoints on market seasonality as well as declining market momentum that could pose as a headwind for U.S. equities.

Seasonality
First up is this monthly seasonal chart by Jon Krinsky, CMT of MKM Partners, as shared by Josh Brown over at The Reformed Broker. Krinsky notes August has averaged a negative decline over the last 30 years but also points out that not every August has been bearish – ’06, ’09, and ’14 were notable exceptions.

Next is a chart I shared on Twitter which is from Tom Thornton’s daily note, Hedge Fund Telemetry. Tom does an excellent job sharing his insights each day in is letter. This chart looks at the decennial pattern of the Dow Jones Industrial Average going back to the early 1900s for years ending in “7”. As you can see, August has been an interesting turning point…. on average for the seventh year of the last 11 decades.

Jeff Hirsch, editor of The Stock Trader’s Almanac, notes that August in a post-election year has not been great for stocks. In fact, it’s the worst month for the Dow and the second worst month for the S&P 500, Nasdaq and Russell 1000 with average declines ranging from -18% to -15%, respective of the index.

Momentum
While discussing U.S. equities we often focus on just the indices themselves, but it’s important to remember that the stock market truly is a market of individual stocks. How those stocks trade is what ultimately impacts the indices themselves. I believe momentum is a powerful tool in stock analysis and can tell us quite a bit on the chart of individual stocks and markets. One such measurement of momentum is the Relative Strength Index (RSI). The chart below shows the average 14-day RSI for each of the stocks that make up the S&P 500. Since March this figure has been in a steady decline of lower highs while the index itself has been grinding higher. What I find really interesting is that we saw something very similar happen during the same time frame last year. In March 2016, the average RSI peaked and began to diverge through August – just before we saw the largest drawdown for that year. Will the same type of price action also follow 2017’s momentum divergence? We’ll see.

Another way to look at momentum is from a lens of being ‘overbought’ or ‘oversold.’ While on a short-term basis being ‘overbought’ can act as a headwind for stocks, it’s often a longer-term bullish sign of strong interest in the stock as buyers push momentum to high levels. By looking at the number of stocks that are seeing a high level of momentum via the RSI indicator we can get a different view of the health of momentum for the overall S&P 500 index. Similar to the chart above, we saw a peak in the percentage of S&P 500 stocks with their respective RSI above 70 (a commonly used level to denote ‘overbought’ status) just above 24%. As the index headed higher fewer and fewer stocks have been able to push their momentum readings above this threshold, with just 6.15% of the S&P 500 stocks getting ‘overbought.’

So there we have it. When looking at the S&P 500, the 50-day Moving Average seems to have become a favorite level of dip-buyers to step up their activity. As of this writing, we are still well above the 50-day as well as the shorter-term, 20-day with the index just a few points off its all-time high. If we do see weakness in equities I’ll be watching the prior June high as well as the 50-day MA as potential support levels. We are still in a well-defined up trend and that shouldn’t be discounted too quickly. There are plenty of catalysts that could keep prices buoyed, but it’s also important to understand the historical market implications and patterns that we also are facing. This should make for an interesting August for sure!

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Complacency in the Volatility Market

I was away from the office for a few days but upon returning it’s nice to see that trades have pushed equities higher as some of the major indices approach their prior highs. However, this has caused volatility to get back under 14 and the level of compression within the $VIX has hit such a level that causes me to give pause.

Volatility of volatility (as measured by VVIX) has fallen back to a level that for the last year and half has marked several low points for the $VIX.

VVIX

This, along with several other indicators that I closely monitor, has me watching volatility right now. While we head into a long holiday weekend, Jason Goepfert of SentimenTrader notes that since 2010 seasonality after Memorial Day hasn’t been extremely bullish for stocks, “Since 2010, the week of the holiday (next week) was positive only once (+1.2% in 2014). The other five years averaged a loss of 1.9%. None of the six years saw the S&P rally any more than 1.5% at its best point during the week.” Not that markets must follow their past playbook, but this negative slant of seasonality paired with what I’m seeing in volatility markets could play out in the bears favor in the coming weeks with a pop in the $VIX. We’ll see what happens.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Expecting A Bounce In Volatility

The S&P 500 has rallied over 10% since the February low, push the index up to its 50-week Moving Average. Meanwhile the Volatility Index ($VIX) has declined approx. 47%, sending the ‘fear index’ to its lowest level so far this year.

One way to use Moving Averages besides in terms of trend identification and areas of support and resistance is measuring how far a security or market is from its specified average price. Currently the $VIX is the furthest it’s been from its 50-day MA since the prior lower high in the S&P 500 back in October 2015. As the chart below shows, it’s now more than one standard deviation below the mean based on the distance Volatility historically travels away from its 50-day.

Previous instances of the VIX falling this quickly has led to tough market conditions in the short-term for equities. As I mentioned on Twitter yesterday, the $VIX is also near its 200-week Moving Average, which has been an important level in the past. Steve Deppe also shared on Twitter that when the VIX that since 1990 when the index’s 20-day return is less than -30%, the average forward return for the S&P 500 over the next 5, 10, 20, and 40 days has been negative.

It’s important to remember that there are two ways that Volatility can correct it’s current stretched condition – time and price. We could see VIX move sideways and remain near 15, allowing its 50-day MA to ‘catch up’ or we could see a bounce sending Volatility higher. We obviously can’t know which option will occur, but it does seem that some form of mean-reversion needs to occur – whether it be via time or a large price movement.

sp500-vs-vix-50d-rsma-params-5y-red-x-x

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.