Small-cap stock surge doesn't mean sell the S&P 500 - but it's going that way

MW Small-cap stock surge doesn't mean sell the S&P 500 - but it's going that way

By Lawrence G. McMillan

VIX volatility index holds clues about the market's direction

The S&P 500 Index $(SPX.UK)$ SPX made new all-time highs this week, both on an intraday and on a closing basis. This rally was accompanied by continuing strength in small caps and other stocks that had previously been out of favor.

On July 17, SPX had a sharp pullback, dropping almost 80 points. But what was quite unusual was that the Dow Jones Industrial Average DJIA was up 243 points, with 22 of the Dow 30 higher on the day. Meanwhile, the market's high flyers were down sharply - costing SPX (Nvidia $(NVDA)$ -6.7% and AMD $(AMD)$ -10.2%, for example). Those two stocks are not in the Dow (yet). The U.S. small-cap index, Russell 2000 RUT was down a mere 1% on the day. So, there appears to be a rotation going on. It has not led to an all-out sell signal for SPX yet, but markets are beginning to move that way.

Currently the SPX chart shows support in the 5,440-5,490 zone, and then at 5,370. A violation of the 5,370 level would be cause for a more bearish interpretation of the SPX chart.

SPX had been trading above the +4<SIGMA> "modified Bollinger Band" (mBB) for some time but finally closed below the +3<SIGMA> Band on July 17. That triggered a "classic" mBB sell signal. We do not trade those, for they are quite subject to whipsaws. However, if SPX continues down from here and trades at or below 5,572, that would generate a McMillan Volatility Band $(MVB.AU)$ sell signal, which we do trade.

Equity-only put-call ratios are still near the lows on their charts, but a separation is beginning to take place. The standard ratio has continued downward almost daily, trading at levels last seen in late 2021. The weighted ratio has begun to rise, and we have tentatively marked that chart with a potential sell signal ("S?"). If it rises any further from here, that would confirm the sell signal. Even so, when these two diverge, it is generally not a strong signal, so we would want to see them both begin to rise before attaching a strong bearish opinion to these charts.

Market breadth has expanded tremendously over the past couple of weeks. This is due largely to the improvement in small-cap stocks. Both breadth oscillators remain on buy signals, and they are in deeply overbought territory. On July 17, breadth was mildly negative. It would take three more days of negative breadth before these breadth oscillators roll over to sell signals. So they're bullish for now.

It should also be noted that cumulative volume breadth $(CVB.AU)$ has been extremely strong. CVB made a new all-time high on 10 consecutive trading days, ending with July 16. This is strong confirmation of the recent new highs in SPX.

The number of new highs on the NYSE has continued to run at very strong levels, completely dominating new lows. This indicator remains bullish as well. The current buy signal would be stopped out if new lows exceed new highs for two consecutive days on the NYSE.

VIX VIX has risen off its lows, closing just above its 200-day moving average $(MA)$. This puts the trend of VIX buy signal in potential jeopardy. If VIX closes above its 200-day MA again today, that would stop out the trend of VIX buy signal. This is not a trend of VIX sell signal, though. That would require the 20-day MA of VIX to cross above the 200-day MA.

The construct of volatility derivatives remains bullish in its outlook for stocks. That is, the term structures continue to slope upwards. There is no inversion in the term structure, not even in the front end. Moreover, the VIX futures are all trading at a premium to VIX.

So, we are remaining in our "core" bullish position, based on the general positive nature of the SPX chart. We will, however, trade all confirmed signals around that "core."

New recommendation: Potential MVB sell signal

As noted above, there is a potential McMillan Volatility Band (MVB) sell signal setting up. The first step in this process - a "classic" mBB sell signal - has been achieved now that SPX has closed below its +3<SIGMA> Band. However, in order to generate an MVB sell signal, SPX must trade lower as confirmation.

If SPX trades at 5,572 at any time, then the MVB sell signal will be complete: Buy 1 SPY SPY (Sept. 20) at-the-money put and sell 1 SPY (Sept. 20) put with a striking price 30 points lower.

This signal, if completed, would then have a target of SPX trading at the -4<SIGMA> Band. It would be stopped out if SPX closed above the +4<SIGMA> Band.

New recommendation: Robert Half Inc. $(RHI)$

There has been a new put-call ratio buy signal in RHI $(RHI.AU)$. Buy 2 RHI (Sept. 20) 65 calls in line with the market.

New recommendation: Walgreens Boots Alliance $(WBA)$

This a longer-term potential buy signal from Walgreens Boots Alliance $(WBA.AU)$. We are keeping this recommendation open but will not continue to reprint the reasoning behind the trade, other than to say that stocks that have been removed from the Dow usually experience a strong rally within a matter of weeks after that removal.

WBA was obliterated after the latest earnings report. The potential MVB buy signal was canceled. So, we adjusted our entry points: IF WBA closes above 13.10, then buy 2 WBA (Aug 9) 13 calls in line with the market.

Follow-up actions:

All stops are mental closing stops unless otherwise noted.

We are using a standard rolling procedure for our SPY spreads: in any vertical bull or bear spread, if the underlying hits the short strike, then roll the entire spread. That would be roll up in the case of a call bull spread or roll down in the case of a bear put spread. Stay in the same expiration and keep the distance between the strikes the same unless otherwise instructed.

Long 3 expiring INSG $(INSG)$ (July 19) 9 calls: Roll to the (Aug. 16) 11 calls. The trailing, closing stop remains at 10.0.

Long 1 SPY (July 26) 561 call: This is our "core" bullish position. It has been rolled up a couple of times.

Long 5 expiring CORZ $(CORZ)$ (July 19) 7 calls: Roll to the (Aug. 16) 11 calls. The trailing stop remains at 8.10.

Long 4 expiring INOD $(INOD)$ (July 19) 16 calls: roll to the (Aug. 16) 20 calls. Raise the trailing stop to 17.50.

Long 2 expiring FIVE $(FIVE)$ (July 19) 105 puts: The stock has collapsed. Roll down to the (Aug. 16) 75 puts.

Long 2 NKE $(NKE)$ (Oct. 18) 75 puts: We will hold as long as the put-call ratio for NKE remains on a sell signal.

Long 1 SPY (Aug. 16) 555 call and Short 1 SPY (Aug. 16) 570 call: This position was established at the close of July 5, when n ew highs on the NYSE numbered more than 100. It would be stopped out if on the NYSE, new lows exceed new highs for two consecutive days.

Long 2 AKAM( AKAM) (Sept. 20) 90 calls: This position will be held as long as the AKAM weighted put-call ratio remains on a buy signal. If AKAM trades at 100, then roll up to the (Sept. 20) 100 calls.

Long 1 UNP( UNP) (Aug. 16) 225 call: roll up to the (Aug. 16) 245 call.

Long 1 CRM $(CRM)$(Aug. 16) 250 put: set a trailing stop at 262 (i.e., sell the put if CRM closes above 262).

All stops are mental closing stops unless otherwise noted.

Send questions to: lmcmillan@optionstrategist.com.

Lawrence G. McMillan is president of McMillan Analysis, a registered investment and commodity trading advisor. McMillan may hold positions in securities recommended in this report, both personally and in client accounts. He is an experienced trader and money manager, and author of "Options As A Strategic Investment." www.optionstrategist.com

(c)McMillan Analysis Corporation is registered with the SEC as an investment advisor and with the CFTC as a commodity trading advisor. The information in this newsletter has been carefully compiled from sources believed to be reliable, but accuracy and completeness are not guaranteed. The officers or directors of McMillan Analysis Corporation, or accounts managed by such persons may have positions in the securities recommended in the advisory.

-Lawrence G. McMillan

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July 18, 2024 12:51 ET (16:51 GMT)

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