Have the Bears Lost Their Mojo?

I would think very carefully before assuming the answer to that is “Yes.” In this article I will review the thoughts expressed in the early weekend review from yesterday, and add a few more thoughts.

In yesterday’s article, I laid out the mounting evidence that—unlike the rally into the December highs—this rally bears a very different character. At that prior high, high yield credit was undamaged, the $VIX was in a bearish structure, and in the decline from that high, breadth weirdly improved. But at this high, high-yield credit is diverging from equities, the $VIX is not in such a structure, and breadth is diverging from price.

That was yesterday and so let us see how things look today.

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High Yield credit continues the divergence we saw yesterday:

Breadth is no better than it was yesterday. It continues to diverge (green lines) and even dropped today in a rising market (small red arrows):

There is one difference on the $VIX. Yesterday I pointed out the inverse that had formed. That was also a clear divergence because the “right shoulder” made a higher low, while the S&P 500 made a higher high. But it fell today, and so we lost the right shoulder. And in fact, today’s low broke just below the prior low, so we’ve lost the clear divergence. This is still sort of a divergence, because really, this is a double bottom on the $VIX while the S&P did not make a double top:

I will return to the $VIX in a moment.

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So, the signals I had yesterday are just about the same today.

I would like to turn now to the structure on the S&P 500.

In the most basic sense, I think this it is in a bearish wedge (green structure) and it has broken out of its down trend (red trend line):

And with that structure, I believe it may be forming an ending diagonal triangle:

In yesterday’s post, I said that I could not promise an immediate drop because these structures can sometimes “overthrow,” and that’s what we got today.

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I said I would return to the $VIX and so let’s do that.

Normally (not always, but often) the VIX likes to “cup” before a major decline in equities. We had that when we had an inverse, but we don’t really have that now. If we had a “cup” here on the VIX, I would be open to a sharp decline—imminently—in equities. And in fact, ending diagonals usually break down swiftly. And that can happen here, the VIX be damned. If it does, I would expect something like this:

But: what if the VIX needs to form a new base? I can’t rule that out now. If the VIX needs more time to form a new “cup,” like this:

I would not expect equities to fall too sharply so quickly. And that opens the door to a proper distribution. If they do that, we might see some real trappy bullshit next week.

A distribution could look like this:

And you can see that the drop for green 1 would look like the ending diagonal is breaking down, but it could be a trap. And then the blue 1 could look like a good retest of the red trend line, and in fact, the whole thing might even end up looking very bull flaggy, like this:

This consolidation above the red trend line and 200-day SMA that we’re all watching would look very convincing. It would eat off a lot of time and frustrate people. And a thought I had earlier today was that a lot of people went into this last CPI announcement expecting a big move (up or down) and the market didn’t move much. And a lot of people might go into this FOMC with similar expectations and honestly, I wouldn’t be surprised if they soaked people on both sides for this “market moving event,” too.

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In sum: if we have completed an ending diagonal, they do tend to breakdown swiftly, and we might do that. But with the VIX weakness today, I think that at least opens the door to something more time consuming like a distribution pattern so the VIX can build a new base. I think a distribution pattern up here would “look” really bullish, but if the VIX cups during that time, if high-yield credit continues to stay muted and if breadth continues to diverge, then I would not trust the structure and would think it had a great chance of failing.

Alright, so that’s what I’m thinking here.

I hope you all have a nice weekend.