Early January Sentiment and Momentum Signals

The 01/06/21 post “S&P 500 Target Reached- Take Profits and Go Short” noted that evidence from three market dimensions, price, time, and momentum indicated at least a short-term US stock market peak could be developing.  Now, evidence from the sentiment dimension bolsters the probably of an approaching decline.

Chicago Board Options Exchange’s CBOE Volatility Index known as VIX measures volatility of the S&P 500 (SPX).  Upward VIX spikes often occur near or at SPX bottoms which makes it an excellent tool to measure bearish sentiment.  The spikes occur with an increased purchases of Put options.  These are downside bets on the stock market. The more Put buying, the greater the fear.

Many traders think that when the VIX is making new lows off of a prior spike it means a top is imminent.  This a wrong assumption, the VIX can occasionally signal a stock market peak but the signals come when the VIX  is making higher lows.

The daily VIX  chart courtesy of Trading View illustrates this phenomenon.

Just prior to the September 2020 SPX correction the VIX was rising. The late October VIX spike corresponded with the SPX bottom.  Subsequently VIX  declined and retraced the spike, however, note in late November this VIX low point did not signal an SPX top. 

If in the next few trading days VIX were to break below its late November bottom it most likely could be a bullish signal for the SPX.  The VIX divergence as of 01/08/21 implies at least a short-term SPX decline is imminent.

The daily NYSE new 52-week high ($NYHGH) chart courtesy of StockCharts.com illustrates internal momentum of NYSE stocks.

The 12/05/20 post “Bullish Booster Shot for US Stocks” noted that the early December surge in Nasdaq new – 52-week highs had bullish implications.  This week Nasdaq had another surge in 52-week highs.  This time NYSE stocks also surged, and it could be an important clarifying momentum signal.

The 12/20/20 post “US Stocks Topping in Early January 2021?” noted the similarities between the SPX bull run from March 2009 to April 2010 with the current rally that began in March 2020. That rally had two peaks  off of the March 2009 bottom.  The penultimate top in January 2010 and the ultimate peak in April 2010.

While it can be assumed that the same phenomenon could happen in 2021 – a top in January 2021 followed by a higher high in April 2021, markets don’t always follow exact parallels.  It’s possible that a high point in January 2021 could be the ultimate top. The early January 2021 surge in NYSE new highs implies the SPX could continue making new all-time highs into at least March 2021 or even into April 2021.

If the SPX is now making a top – a high probability given the evidence from all four market dimensions,  the peak could be just short-term.  If the SPX follows the pattern of the January 2010 decline, a move down in January 2021 could last about two to three weeks, falling about 8 to 9%.

Traders are short 50% non-leveraged SPX funds as of the open of SPX trading on 01/07/21. Continue holding short.