Reversal Or Continuation?

The astonishing late-day reversal on increased volume by the S&P 500 Index last Monday creates a dilemma. Either the reversal halts the decline or it becomes the first point of a continuation pattern. The Market Review offers some thoughts along with a contrarian long idea for Johnson & Johnson (JNJ) from Friday's Stock Trend Analysis in Underlying Sentiment Analyzer.

S&P 500 Index (SPX) 4431.85 made a valiant attempt to recover some of the loss incurred the week before by gaining 33.91 points or +.77% last week. Few market observers can seriously dispute it was oversold last Monday and due for a bounce. During sustained pullbacks or bear markets, shorts typically cover on Friday to reduce risk from a surprise event over the weekend with the potential to turn sentiment positive thereby increasing the odds in favor of short covering for a good part of Friday's 105.34 point gain, closing just under resistance from the 200-day Moving Average.

Perhaps last Monday's reversal and Friday's gain will triumph and halt the decline near the level reached last October 4 at 4278.94. If so, the reversal scenario prevails like many others during this long bull market. Alternatively, last Monday's decline down to 4222.62 before reversing could be point one of a developing continuation pattern underway. Bulls want closes above the 200-day Moving Average, now 4435.04, while bears prepare for closes below 4222.62.

CBOE Volatility Index® (VIX) slipped 1.19 points or -4.12% last week ending at 27.66. Our similar IVolatility Implied Volatility Index Mean, IVXM using four at-the-money options for each expiration period along with our proprietary technique that includes the delta and vega of each option, declined 1.52 points or -6.30% to end at 22.59% vs. 26.67% on Wednesday, January 26 at the peak shown in the chart below, the day Jerome Powell spoke after the Federal Open Market Committee meeting. The SPX pushed up 84.75 points when he began, fifteen minutes later still up 60.82 points, then it turned negative and interest rates on Treasury securities advanced across the curve before he finished.

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VIX Futures Premium

VIX futures premium daily version, ended Friday at -2.58%, in the red bear zone, vs. week ago Friday, January 21, at -5.56%, with 16 days before front-month February futures expire.

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Near the bottom of the recent range since May 2020, this indicator favors the SPX reversal alternative whereby the VIX declines back below the futures curve and the premium turns positive.

The chart reflects the distance from the VIX to the futures curve computed from the two front-month contracts. Since most of the volume and open interest are in the two closest futures contracts measuring the volume-weighted premium relative to the standard 30-day VIX provides a good real-time sentiment indicator based upon actual commitments of large Asset Managers and Leveraged Funds.

Market Breadth as measured by our preferred gauge, the NYSE ratio adjusted Summation Index that considers the number of issues traded, and reported by McClellan Financial Publications. Last week's downside momentum increased as it declined 380.14 points, in addition to a 234.81 point decline the week before, to end Friday at to end at -549.36. As the chart shows, it's now below all of the recent troughs with the exception of March 24, 2020, at -1256.95 during the Covid shutdown period. The bears growl loudly when looking at this reliable indicator.

Contrarian Idea

Presuming downward best describes the path of least resistance for the SPX considers this contrarian/rotation into safety idea.

As a regular feature in the Options Data Analysis and Rankers & Scanners sections on our front page display results from the Underlying Sentiment Analyzer included with all IVolLive packages, based upon the short-term market trend, which considers the Historical Volatility term structure, call/put ratio, exponential moving average, 14 day RSI (relative strength index), and the 21 day Chaikin Money Flow. Friday's pick confirms rotation into defensive sectors such as Health Care and Consumer Staples.

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Johnson & Johnson (JNJ) 171.79 gained 6.92 points or +4.20% last week after dropping as low as 158.26 on Monday before rocketing back up.

Strategy

After much-anticipated comments by Jerome Powell last Wednesday, the S&P 500 Index as well as other major indices attempted to rebound Friday, likely due to short covering.

While it's not clear if last week's attempted rebound represents the first step of a reversal or part of a continuation pattern lower, this week's activity will help decide with both resistance and support levels well defined.

Summary

Despite stunning gains made last Friday by the S&P 500 Index (SPX) and other major indices, the forward path remains to be determined, with the SPX at resistance under the 200-day Moving Average as a potential continuation pattern develops with implications for further declines helped by rapidly deteriorating market breadth. While the bulls wonder if last week's reversal can be sustained the bears prepare for another leg down.

Disclaimer: IVolatility.com is not a registered investment adviser and does not offer personalized advice specific to the needs and risk profiles of its readers.Nothing contained in this letter ...

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