MW Yes, stocks are pricey and too popular - but overbought does not mean 'sell'
By Lawrence G. McMillan
December typically delivers seasonal gains from the 'Santa Claus Rally' and the 'January Effect'
The S&P 500 SPX has reached new all-time highs again this week. The chart for the benchmark U.S. market index is still positive, and so we're maintaining our core bullish position.
That said, many internal indicators are beginning to register overbought conditions. Still, as is often heard on Wall Street, "overbought does not mean sell." That is, the stock market can continue to rise and remain overbought for long periods of time without generating confirmed sell signals.
On the SPX chart, there is support at 6,010, the most recent previous resistance level. Below that, there is much stronger support at 5,870. A move below 5,870 would be cause for concern. Furthermore, a move below even stronger support at 5,670 would be extremely negative. But we don't view those as viable possibilities in the short term.
There is no resistance, per se, when SPX is at all-time highs. The best target we have is the +4<SIGMA> "modified Bollinger Band," which is at 6,150 and rising. That is also the target for the McMillan volatility band $(MVB.AU)$ buy signal, which began in August and is still in place.
All of the above-mentioned points are marked on the SPX chart below, along with a circled area, which is a bullish "island reversal" formation that is also still in effect.
Equity-only put-call ratios have plunged to new lows for the year, and that is an overbought condition. In doing so, they are at levels last seen in late 2021 - just before the last bear market started. The difference between now and then, though, is that the ratios are still declining (which is bullish for stocks), while they were rising in late 2021. So, these ratios are in a bullish state currently (albeit in overbought territory), and they won't generate sell signals until they roll over and begin to rise steadily.
Market breadth has probably been the least bullish of the indicators recently. On two days this week when SPX was rising, breadth was negative. Even on Dec. 4, when SPX pushed strongly to a new all-time high, breadth was barely positive. The NYSE-based breadth oscillator has generated a sell signal, but the "stocks only" breadth oscillator has not. If both eventually generate sell signals, that would be worth a trade.
New highs on the NYSE continue to outnumber new lows on a daily basis. That is bullish for stocks, and it keeps the indicator bullish. That status would only change if new lows were to outnumber new highs for two consecutive days on the NYSE.
VIX VIX is just above 13, which is near the yearly lows. That is yet another overbought condition. The "spike peak" buy signal of Nov. 6 will be in effect through Dec. 9 (the trading system we built around these peaks calls for holding the position for 22 trading days).
Another buy signal has emerged, though, and that is the trend of VIX buy signal. This occurred when the 20-day moving average $(MA)$ of VIX crossed below its 200-day MA. That is marked with a square on the VIX chart below. You can see two previous squares (i.e., buy signals) in the past year. Those buy signals last until VIX crosses back above the 200-day moving average - circles on the chart. So, while VIX itself might not be trending lower, the stock market generally trends higher while these conditions are in effect.
Plus, this is a seasonally bullish period. The post-Thanksgiving rally has taken place, and now we are moving into the "January Effect" (which takes place in December these days). The "Santa Claus Rally" is expected near the end of the year.
Finally, the construct of volatility derivatives has returned to a fully bullish outlook for stocks. The term structures of the both the VIX futures and of the Cboe volatility indices slope steeply upward, and the VIX futures are trading at large premiums to VIX.
In summary, we continue to maintain a core bullish position. We will add other confirmed signals around that, and we will continue to roll deeply in-the-money calls up in order to take partial profits and reduce downside risk.
New recommendation: Trend of VIX buy signal
There is a new trend of VIX buy signal. Buy 1 SPY (Jan. 17) at-the-money call and sell 1 SPY (Jan. 17) call with a striking price 15 points higher.
We will hold this position as long as VIX is below its 200-day MA. Stop out if VIX closes above its 200-day MA for two consecutive days.
New recommendation: LKQ Corp. $(LKQ)$
This is a repeat recommendation from last week, since the condition has not yet been satisfied. There is a recent weighted put-call ratio buy signal in LKQ (LKQ). However, we want to see the stock be able to rise above resistance at $40, so we are making this a conditional recommendation.
If LKQ closes above 40, then buy 3 LKQ (Feb. 21) 40 calls in line with the market.
If the calls are bought, we will hold as long as the weighted put-call ratio remains on a buy signal.
New recommendation: Arch Capital Group Ltd $(ACGL)$
There is a new put-call ratio buy signal in ACGL (ACGL). The stock has broken out over resistance, so there is no need for a conditional recommendation here.
Buy 3 ACGL (Jan. 17) 100 calls in line with the market.
We will hold as long as the put-call ratio buy signal is in effect.
Follow-Up Action:
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.
Also, for outright long calls, roll up if they become eight points in-the-money.
Long 1 expiring SPY SPY (Dec. 6) 603 call: The 595 call was rolled up to the 603 calls this past week.
Now roll to the SPY (Dec. 27) 607 call. This position is based on the new highs vs. new lows buy signal. It was entered via a bull spread bought at the close of trading on Aug. 15. It was then rolled several times. It would be stopped out if, on the NYSE, new lows outnumber new highs for two consecutive days.
Long 1 expiring SPY (Dec. 6) 603 call: The 595 call was rolled up to the 603 calls this past week.
Now roll to the SPY (Dec. 27) 607 call. This is our core bullish position. Stop out of the position if SPX closes below 5,870 for two consecutive days.
Long 4 WBA $(WBA)$ (Dec. 27) 9 calls: This is the "alternative" Dogs of the Dow position. Hold without a stop at this time.
Long 2 APH $(APH)$ (Jan. 17) 62.5 calls: We will hold these calls as long as the weighted put-call ratio remains on a buy signal.
Long 1 SPY (Dec. 20) 595 call and Short 1 SPY (Dec. 20) 615 call: This position is based on the most recent VIX "spike peak" buy signal. This position will be held for 22 trading days - or until Dec. 9. It would be stopped out if VIX were to return to "spiking" mode. That is, if VIX were to rise at least 3.0 points over any one-, two- or three-day period. Today, that stop would be a VIX close at or above 16.64.
If not stopped out, exit this position at the close of trading on Dec. 9.
Long 3 MSTY MSTY (Dec. 20) 31 calls: Stop out on a close below $30 by MSTY.
Long 4 UNG UNG (Dec. 20) 13 calls: Sell these calls since the weighted put-call ratio for natural gas futures is no longer on a buy signal.
Long 2 IWM IWM (Jan. 17) 241 calls and short 2 IWM (Jan. 17) 254: This is the post-Thanksgiving seasonal trade. We will plan to hold this trade through the second trading day of 2025, so the entire amount of the money in this trade is at risk. If IWM trades at 254, then sell the spread and replace it by buying the IWM (Jan. 17) call at that higher strike, holding it as an outright long.
Long 4 IEF IEF (Jan. 17) 94 calls: We will hold as long as the weighted put-call ratio for these U.S. Treasurys is on a buy signal.
Long 10 POET $(POET)$(Jan. 17) 5 calls: Sell the calls if POET closes below $4.25.
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 is the 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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December 05, 2024 16:22 ET (21:22 GMT)
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