Are We Scared Yet?

Well, our commentary on June 22 in Is it really 2001 again? certainly proved timely. Big Ben stepped up to play the role of boogeyman again and the markets took a tumble last week. The Dow Jones Industrial Average (DJIA) found new lows while the S&P 500 (SPX) tested the lows from March. Everything was going exactly to plan, or was something missing?

We got the plunge and decent volume developed, but where is the fear? The put/call ratios moved just slightly higher (technically negating the previous two buy signals) but the Volatility Index (VIX) barely budged. The VIX has not even set a new local high, let alone challenged the previous support line from below a second time. As for a climactic fear spike, forget it.

I was hoping to see futures down sharply this morning before the open. I wanted that last gasp of sellers throwing in the towel, fearing for their financial lives. I just can’t call myself genius or jacka$$ enough to make this call for a bottom at this point. The market is certainly oversold and much cheaper than the week before. The lows on the SPX have held, so far. But I would still be on the lookout for that washout day. Any rally until that point is suspect, especially at this time of year.

It is very possible that a dead cat, oversold bounce develops here only to succumb to a washout day later into the summer. Depending on the levels at the time, new lows in the SPX may or may not need to be reached to create the climactic fear spike we are looking for. At this point, I think we may need at least more time, if not more dramatic price action on the downside.

**Note this bottom could develop without the fear spike confirmation. I am certain we will see another fear spike before the fall, but it may come at higher price levels. Though rare, and not as certain, this lack of fear at the old lows could signal a positive divergence as the market is simply scared straight. If everyone is prepared for the new lows, they may not manifest themselves. This lack of capitulation could be an indication that the peak in fear has passed. This is a dangerous call, much easier to determine in hindsight, but not an impossibility. To straddle the fence so to speak, consider entering a portion of your longs here at the old lows, but be prepared to exit if the old lows are eventually broken or to purchase additional shares at lower prices.

Adding additional strength to this argument is the textbook definition of one of my favorite price patterns, the Head and Shoulders Bottom: A bullish reversal pattern marked by three (or more) prominent troughs with a middle trough (the head) that is lower than the other troughs (the shoulders). When the trendline (neckline) connecting the peaks at the top of the pattern is broken, the pattern is complete. See ChartSchool article on Head and Shoulders Bottom (Reversal). Digging further into the ChartSchool article reveals “the right shoulder’s decline should be accompanied with light volume. . . The most important moment for volume occurs on the advance from the low of the right shoulder. For a breakout to be considered valid, there needs to be an expansion of volume on the advance and during the breakout.”

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