Diary of a Financier

Equities & volatility synchronize watches

In Capital Markets on Wed 26 Dec 2012 at 16:45

For a couple of months now, I’ve been covering analogues I’m finding across multiple asset classes, which all suggest a deep correction is due in 1q13. That includes historical precedents governing precious metals (2009), tech (2007), volatility (2011), the US Dollar (1996), and politicians (2008 & 2011). As noted parenthetically, not all originated from the same time period, yet they’re all aligning today, in real time. Earlier today, I mentioned bullish short term stirs within the equity space–a development that should lead SPX to the threshold of correction according to the technicals. Indices had started warning of a top in weekly fractals months ago, then daily fractals followed a few weeks ago, and now intraday charts are currently working toward that end. This is occurring in coordination with volatility–an important confirmation that redoubles my conviction.

Like I said this afternoon, SPY and QQQ have reached preliminary support levels in their intraday fractals. The pattern constructions suggest a short term Head & Shoulders top could be developing in each, which would send the indices higher from these would-be necklines to right shoulder resistance.

First, I’ll address the S&P 500’s 30-minute chart, wherein you’ll notice the early stages of that H&S with bull divergence appropriately burgeoning (despite a late day bear raid this afternoon). Were the H&S to materialize, SPY should rally to right shoulder resistance between $143.5-144.5 (+1.6%):

SPY 30-min- potential H&S top at neckline w bull divergence; rally up to R shoulder resistance ~$143.5-144.5

SPY 30-min- potential H&S top at neckline w bull divergence; rally up to R shoulder resistance ~$143.5-144.5

Same goes for the NASDAQ, for which QQQ’s right shoulder target is between $66.0-66.3 (+2.3%):

QQQ 30-min- potential H&S top at neckline w bull divergence; rally up to R shoulder resistance ~$66.0-66.3

QQQ 30-min- potential H&S top at neckline w bull divergence; rally up to R shoulder resistance ~$66.0-66.3

As if the stock market’s mercenaries were synchronizing their watches, the Volatility Index (VIX) concurs. I shot out a note about this before today’s close, when VXX had formed a rounded top intraday with early-stage bear divergence in its 30-minute fractal:

VXX 30-min- bear divergence after today's intraday rounded top

VXX 30-min- bear divergence after today’s intraday rounded top

Volatility is cheap right now, all things considered. In fact, I allocated 1% of our portfolio to VXX at the lows on Monday afternoon, when a two day falling wedge (part of a larger bull flag) had worked itself into a vertex, primed for a breakout as markets closed early on Christmas Eve. (That read was affirmed by today’s gap up on the open.)

Here, it’s important to highlight the null hypothesis embedded in the VXX chart–the weakest link in this chain. Albeit low probability, there’s a chance that VXX used the aforementioned late-day selloff in stocks to start a breakout of a short term bull flag.¹ That would ruin the coordination I’ve observed across the equity/equity derivatives landscape, then I’d have to reassess the whole short term outlook.

As I write this, SPY is trading down around 20-25 bps postmarket, so I’m psychologically squirming. The H&S patterns are not neatly classical, they’re tilted downward, which means there’s little room for any slip lower; if the H&S thesis fails, at least it’ll fail pretty quickly and definitively. Such failure would morph QQQ’s 30-minute chart into a broken-down consolidation channel, portending a continued risk-off slide. That instant gratification affords me the luxury to either derisk or sit on my hands after seeing tomorrow’s trend.

The bigger picture cannot be lost amidst this minutia. Yes, I expect the risk-on switch to be engaged in the near term, but I maintain my bearishness for the ensuing period (January/February)
–Romeo

¹The actual VIX index agrees with the signals in VXX. VXX is an ETF with a horrible record for tracking its index (short term volatility), due to contango in the VIX futures curve and low liquidity/arcane underlying contracts. I’ve had good and bad experiences with VXX, from which I’ve learned my lessons. I’ve employed the ETF today because the fiscal cliff has Treasury bonds acting weirdly (i.e. not catching the flight-to-safety bid I’d hope for).

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  1. […] a followup to my entry last night, the multiday Head & Shoulders failed in both SPY and QQQ.  With SPY having been […]

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