Saturday, November 15, 2014

The Rubber Band Is Stretched--Will It Break?

A rubber band can remain stretched for some time, but it takes some force to keep it stretched.

The consensus is anticipating a smooth sleigh ride for Santa's traditional stock market rally from November to year-end. But the rubber band of the current rally is looking quite stretched, and there's a distinct possibility the rubber band snaps and Santa's rally hits a rough patch and overturns, distributing lumps of coal rather than additional equity gains.

Exhibit 1: The Russell 2000 index (RUT). It's hard not to notice that MACD is about to cross in a bearish signal, and that the stochastic has already crossed and is heading south.

Then there's the open gaps below, which tend to get filled despite endless claims that "this rally is different." Yes, of course it is.

At the previous top, the RUT noodled around in a trading range for a couple of weeks, reaching for a breakout that quickly failed.

The RUT has repeated the pattern rather neatly: two weeks of going nowhere (a.k.a. distribution), and a breakout that quickly reversed.

It's also interesting that the RUT's runs seem to last around 20 days or so. The downturn in October lasted about 22 days, and the current run-up is stretched tight at 24 days.

Exhibit 2: the volatility index (VIX). As Zero Hedge has noted, the VIX exhibits a peculiarity at the close of each trading session: it drops precipitously in the waning minutes of trading, and equally magically, stocks pop up to close positive for the day.

That this sudden slam at the close has happened every day this past week must be coincidence--right?

Meanwhile, we see the stochastic has turned up and the MACD is poised to cross as well. The huge gap yawning around 24 is meaningless to complacent kiddies awaiting more equity-gain goodies from Santa. What's the basis of this confidence that volatility has been eradicated? This rally is different. Yes, of course it is.

Mr. VIX keeps getting slammed at day's end, but he still managed to notch an uptrend:

A rubber band can remain stretched for some time, but it takes some force to keep it stretched. In this case, the force is the daily VIX body-slam and the resulting pop up in equities. This has worked to keep RUT and its cousins aloft for several weeks of going nowhere, but the chart suggests all the kiddies who are supremely confident that Santa will deliver more equity gains might find their complacency is not rewarded.

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