It shouldn’t come as a surprise that the bulls took a breather after rallying the markets some 7% so far this week. If anything, what’s surprising is the fact that the markets haven’t given up any of their gains from the week. Such a fact underlines the psychological shift we believe has taken place in the market in the last 24 hours. That’s not to say the markets won’t pull back, a 7% rally is not likely to go without interruption, and there a couple signs that a pullback could come as early as tomorrow.
We’ve pointed out before that when the S&P500 has rallied and the VIX has declined and then the two trade in a tight range together, this seems to be a short term topping pattern in SPX. You can see examples of this on 8/31, 9/20, and 10/28. Well SPX has rallied 7% this week and the VIX has declined 20% so the first part of the equation is there. Secondly, SPX traded in its tightest range after a rally since 10/28 and the VIX in its tightest range after a decline since 10/28 as well. So if this pattern plays out as it has in the past we should see a pullback tomorrow.
Adding to the case for a pullback tomorrow is the higher low put in the U.S. dollar index. Yesterday the dollar hit a low of $77.92 and today its low was $78.08. The dollar is still maintaining its uptrend and this higher low, along with the pattern in SPX/VIX could pave the way for some red tomorrow. With that said, the main difference between now and 10/28 is that markets hadn’t rallied so fiercely leading up to that day. Because of the swiftness of this rally many shorts are likely trapped at lower prices and many would be bulls are likely on the sidelines. Those are the main reasons that if the markets do pullback we’ll be buyers as we still anticipate a rally into year end.
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