It’s Always Darkest Before the Dawn but Everything is Well Oversold Now.

It's All About the Middle East and when Bond Yields Reverse

The stock market continues to wobble as the uncertainty in the Middle East and the persistent rise in bond yields is raising the worry meter for traders.  On the other hand, reliable fear gauges are registering readings which are increasingly reassuring while bonds, the market’s breadth, and the major indexes are nearing potential reversal points.

The CBOE volatility index has been rising of late, breaking above 19 for the first time in several months. This morning, though, it’s not advancing.  That’s a sign that traders have been buying put options, but the negative momentum may be slowing. 

When traders buy put options, it forces market makers to sell stock index futures to hedge against losses.  It’s those stock index future purchases by the market makers that drive stock prices down.  Because market makers usually sell S&P 500 (SPX) futures as a hedge, you see the weakness in SPX more than in other indexes, although most indexes follow the downdraft.

Meanwhile, the CNN Fear-Greed Index is at 40 this morning, well into the Fear camp, which is encouraging.  The lower that index falls, the more likely we are closing in on a potential bottom.

This morning, the S&P 500 opened below its 50-day moving average, but also below its lower Bollinger Band.  Moreover, the RSI is closing in on an oversold reading of 30.  Note also the reversal in the market that is trying to develop as SPX tests the bottom of that VBP bar around the 5050 level.

A look at the ADI and OBV lines suggests that yesterdays selloff was a bit of a panic as the OBV line was weaker than the ADI line.  Remember, the ADI line tells us what short sellers are doing while the OBV line tells us about what investors are doing (real buyers and sellers).

The New York Stock Exchange Advance Decline line (NYAD) is trading well below its lower Bollinger band.  Expect a reversal here at some point, as this is the type of trading pattern that suggests panic selling, which is often the prelude to a tradeable bottom.  Note also that RSI for NYAD is now at 30, which is an oversold reading.

The bond market is clearly spooking investors as the U.S. Ten Year Note yield (TNX) is near the 4.7% area. A move above 4.7% would be very negative.  On the other hand, TNX is also over extended as it’s trading above its upper Bollinger Band and its RSI is nearing 70. A reversal, at some point, is likely.

Altogether, the current market action suggests that whether are at a potential reversal point.  It may not happen today, or tomorrow.  But the longer this type of action continues, the more oversold, and prone to reversal the markets will become.

It’s what happens when that reversal develops that really matters.  So, for now, even though the current trading pattern is uncomfortable, staying patient is what matters most.   If the market fails to fully reverse its current bearish stance, and the oversold bounce that is likely to happen in the next few days fails, then we will have major worries.

For now, we let the market do our work via sell stops. If a position is holding up, keep it.

I am watching this situation carefully and building a shopping list in preparation for what’s next.

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