The stock market could be on the verge of a “tradable” rebound, according to a key technical indicator

Heading into Monday’s close, US equities look set for another tough week as Treasury yields rose and the global dollar outburst continued.

As the S&P 500 was poised for its lowest close since November 2020 on Monday, market technicians were once again focused on the Cboe Volatility Index – along with a host of other technical indicators – to try to discern when the next rebound in equities might begin.

Monday the VIX was VIX,
+7.82%
trading above 31, leaving it on track to close above 30 for the first time since June 21.

The level of the VIX could be an important level to watch, according to Nicholas Colas, co-founder of DataTrek Research. In a note to customers on Monday, Colas pointed out that although the VIX has yet to break above 40 – a level that has been reached in virtually every major sell-off in the past 20 years before a market bottom hit sustainable – there might be another more useful level to watch out for.

See: Can the stock market melt without Wall Street’s fear gauge reaching “panic” levels?

Why hasn’t the VIX reached 40 yet?

Why haven’t we seen Wall Street’s fear gauge rise this year?

To some on Wall Street, the VIX seemed conspicuously constrained given the level of realized volatility seen in the market this year. The S&P 500 has already recorded 47 daily declines of 1% or more since the start of the year. That’s the most in a single year since 2002, according to Dow Jones Market Data. And there are still three months left.

That’s well above the 20-year average of 23.6.

And yet, the VIX peaked at 36 in June. Why not higher?

It’s hard to say exactly, but ultimately it may not matter. Because, as Colas pointed out, multiple closes above the 30 level have, so far this year, been a more reliable indicator of an impending turnaround. Colas tells you more below:

  • “The VIX has closed above 36 (2 standard deviations above its long-term average) only once this year. That was March 7 (close 36.5). “It lingered above 30 for the next 5 trading sessions. It was a tradable low: the S&P 500 was up 11% through the end of March.”

  • “The next time the VIX spent 5 days above 30 was May 5-12. The S&P then rebounded 6% through June 2.”

  • “The last group of +30 VIX closes this year came around the June 16 lows, and the S&P was up 17% through mid-August.”

If this pattern were to repeat itself, investors could already be on the verge of entering a “tradable” entry point.

But there are other important levels to watch that are tied to Wall Street’s “fear gauge.”

The VIX futures curve, which reflects expectations about the potential volatility of the S&P 500, has “inverted” since Friday – a phenomenon that last occurred in June. According to FactSet data, the VIX futures curve is currently inverted through December 21.

The latest market turmoil has been a boon for VIX traders. Individual investors can gain exposure to the Volatility Gauge in several ways, including by purchasing options or exchange-traded products such as the Barclays iPath Series B S&P 500 VIX Short-Term Futures VXX.ID Exchange Traded Note,
+3.42%
or ProShares Ultra VIX Short Term Futures UVXY Exchange Traded Fund,
+5.49%.

Other indicators of a “negotiable” bottom

Yet, the gap between the spot level of the VIX and where the VIX futures are trading for delivery on December 21st is only a few points.

As Johnathan Krinsky, Chief Market Technician at BTIG, pointed out in a recent note to clients: “We didn’t have a big reversal in June, and while we may never get it, the History says we didn’t see a ‘final’ low until we got at least a 10 point reversal.

Another factor that may have exacerbated the latest market decline is the level of put option buying – which helps investors hedge against further declines – relative to the amount of call buying (calls pay out when the shares exceed a certain level, known as the “strike price”).

According to Renaissance Macro’s Jeff deGraaf, the put-call ratio for US CBOE stocks hit 1.29 on Friday, near its highest level since June. So far this year, this level has coincided with positive returns for equities three months later.

See: This stock market milestone indicates the S&P 500 could be up to 16% higher within a year

But as the S&P 500 approaches its intraday lows from June, there is another, lower level that may be a more reliable indicator that the latest selloff in stocks is approaching a point of exhaustion.

This level corresponds to the 200-day moving average of the S&P 500, which is 3,585.

“With the index essentially there and some modest capitular signals playing out, we believe a tradable bottom is approaching. The question is from what level. of 200 weeks (3,585) makes sense to us, especially if we see a broader inversion in the VIX curve,” Krinsky wrote.

Lori Calvasina, head of US equity strategy at RBC, believes the next key level to watch will be 3,500 once the June lows are broken.

See: The stock market is about to take a big test: watch this level of the S&P 500 if the 2022 low gives way, according to RBC

While it’s tempting to rely on technical indicators that may have worked in the past, real yields and the dollar are significantly higher than they were even three months ago, Krinsky pointed out.

The ICE US Dollar Index DXY,
+0.82%
is trading at a 20-year high north of 114. And the 2-year Treasury yield TMUBMUSD02Y,
4.347%
Monday hit its highest level since October 2007 as global bonds enter bearish territory.

See: Global bonds are in their first bear market in 76 years based on two centuries of data, according to Deutsche Bank

Krinsky thinks the dollar will have to at least pause its relentless march higher before stocks can rebound.

The Nasdaq Composite COMP,
-0.60%
was down 0.5% at 10,817, still slightly above its June closing low, while the Dow DJIA,
-1.11%
was down 1.2% at 29,238, leaving it on track to enter a bear market after ending Friday at its lowest level since November 2020.

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