The major US equity indices have now dropped for three weeks. Amidst this, last Friday’s action should bode well for the bulls – at least in the near term.

The ratio of VIX to VXV ended last week at the highest level since October 2020. Readings above unity are rare. Last week, the ratio closed at 1.035 (Chart 1). If past is prologue, unwinding of this overbought condition stands to benefit stocks.

VIX measures market’s expectation of 30-day volatility on the S&P 500. VXV does the same, except it goes out to three months. When the investing climate is risk-off, as has been the case of late, demand for VIX-derived securities is higher than, let us say, VXV. The opposite is true when investor sentiment firms up.

Last week’s close above one firmly puts VIX:VXV into extended territory. A likely unwinding of the overbought condition will translate into VIX underperforming VXV, helping put the S&P 500 under upward pressure.

The S&P 500 gave back 3.1 percent last week to 5770. This was the third weekly drop in a row. Earlier, the large cap index reached a fresh all-time high of 6147 on February 19^th and then retreated (Chart 2).

Last week began on an optimistic note, but bears showed up as soon as the 50-day (now 5982) was unsuccessfully tested; the average is now turning lower. By Friday, the S&P 500 was down 7.8 percent from last month’s high, and the intraday low 5666 generated buying interest, with the 200-day at 5733 breached intraday but reclaimed by close.

The daily is grossly oversold, and Friday’s action should encourage risk-on – duration and magnitude notwithstanding. Last week’s close lands the index right onto 5770s resistance. Once this gets taken care of, there is horizontal resistance at 5870s, followed by the 50-day at 5982.

Things pretty much evolved similarly over at the Nasdaq 100, except tech bulls just fell short of the 200-day (20248). Closing at 20201, the index fell as low as 19737 on Friday – down 11.2 percent from February 19^th when it reached a fresh all-time high of 22223.

Friday’s reversal also ensured the tech-heavy index closed above horizontal support at 19990s (Chart 3).

Ahead, there is crucial lateral resistance at 20500s. The downward-sloping 50-day lies at 21340.

But based on how the small-caps are behaving currently, it is hard to imagine a sustained risk-on behavior.

Unlike the two large-cap indices above, the Russell 2000’s four percent decline last week made up a sixth consecutive weekly drop. It has been under pressure since November 25^th last year when a new all-time high of 2466 just nudged past the prior high of 2459 from November 2021.

Last Friday, the small cap index dropped all the way to 2034 before recovering to end the session/week at 2075. This also meant a much-anticipated breakout retest at 2100, which the index broke out of 2100 last July, failed; this follows a successful retest last September (Chart 4). The sooner small-cap bulls reclaim the level the better the odds of a rally toward the 200-day at 2204, with the 50-day at 2239.

A decline in volatility should help.

As is evident in Chart 1, VIX needs to drop more than VXV for the ratio to begin to head lower. And the stars could be lining up for this.

VIX went from sub-15 mid-February to north of 26 last Friday before coming under pressure. Friday’s intraday print of 26.56 was the highest print since December 18^th when it spiked to 28.32 before reversing lower.

Closing out at 23.37, VIX was up 3.74 points last week. This was the third positive week in a row. Since last September, 23 – or thereabouts – has stood like a rock for volatility bulls, and this likely continues for now (Chart 5).

Importantly, the weekly RSI closed last week at 61.18. Several times in the recent past, with an exception last August, this metric has retreated from around here.

More By This Author: