Market Volatility: A Potentially Bullish Signal for the S&P 500

In the ever-volatile landscape of the stock market, particularly with the S&P 500 index (SPX), the current environment offers both challenges and opportunities. As the index approaches significant resistance between 5,700 and 5,800—an area that also includes the declining 200-day moving average—the stakes couldn’t be higher. A move above 5,800 would signal a bullish trend, but many indicators suggest it’s not going to be an easy ride. Investors and market watchers need to exercise caution and astuteness.

Resistance and Support Levels: The Path Ahead

The SPX has demonstrated resilience, maintaining significant gains since its early April lows. Along the path to its current position, it has encountered multiple support levels: 5,440, 5,300, and 5,100, alongside the crucial April lows in the 4,850-4,950 range. These levels create a framework within which the market can move. However, should the index fail to break above the resistance of 5,800 and instead retreat, we could witness a bearish trend setting in—characterized by lower highs and lower lows.

For instance, the index’s movement this week illustrates this precarious balance. A peak at 5,700 followed by a pullback could set a new downward trajectory. If SPX continues to slide from these critical levels, it would conjure up a bearish outlook, warranting caution from conservative investors.

Technical Indicators Pointing Bullish

On the technical side, the market has shown several bullish indicators. A full McMillan volatility band (MVB) buy signal was generated when SPX rose above 5,575 at the end of April, targeting the +4% band near 6,000 while the -4% band sits at 4,950 and is on the rise. As realized volatility begins to decline, the MVB signal becomes increasingly important to monitor.

Equity-only put-call ratios are also flashing bullish signals; as these ratios decline rapidly, they suggest a positive outlook for stocks. Until there’s a significant upward reversal in these ratios, investors can maintain a bullish stance. Market breadth remains positively inclined as well, with oscillators indicating continual strength, despite some transient negative breadth days that haven’t derailed the overall positive trend.

Understanding Volatility: Realized vs. Implied

One of the critical dynamics at play is the disparity between realized volatility—measured using the 20-day historical volatility (HV20) of SPX—and implied volatility (VIX). Recently, we’ve observed a remarkable differential: with VIX at 24 and HV20 at 50, the VIX-HV20 differential of -26 reflects a market experiencing substantial swings, indicative of high realized volatility.

Historically, such periods where realized volatility surpasses implied volatility often lead to bullish trends in the intermediate term. Yet, the separation between VIX and HV20 is noteworthy; it has only dipped below -10 on a few occasions, and our analysis suggests that monitoring this differential can yield fruitful insights.

Volatility Signals: Staying Alert for Buy Opportunities

As we evaluate the current state of volatility, the VIX is slowly declining, backing up the “spike peak” buy signal from April 9. It is critical to note that, according to our trading system, we are exiting these positions after 22 trading days. The overarching trend also indicates a VIX sell signal, as it remains above its 200-day moving average, reflecting ongoing pessimism among traders.

The inversion in the term structure of VIX futures remains significant. Bullishness becomes evident when term structures slope upward—a state we have yet to return to since the pandemic crisis in March 2020.

Conclusion: A Mixed Outlook Amidst Volatility

The current market landscape presents a mixed outlook. While we continue to maintain a low-delta “core” bearish position for SPX, the confirmed bullish signals in other sectors warrant attention. We will persist in trading around these signals while rolling deeply in-the-money options. It is essential for conservative investors to remain vigilant and discerning as we navigate these tumultuous waters, reminding ourselves that volatility, though often viewed negatively, can also present substantial opportunities for those ready to seize them.

Overall, discerning the nuances of volatility and market behavior will be crucial as we move forward. With patience, diligence, and unwavering adherence to traditional financial principles, there may be a path to prosperity even amid uncertainty.