Is the S&P Preparing For A Pull Back?

Is the S&P Preparing For A Pull Back?

Volatility is up and the index is down so far for September. Should we be preparing for a correction?

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After shattering record highs in August, the S&P 500 has started September by moving in the other direction. 

While the index is now officially out of the correction territory formed by the drop in February, there is significant speculation now about which way the index might head, and if we are nearing another possible correction scenario.

 

Is the S&P Headed for a Pullback?

 

Many analysts are pointing to an elevated VIX, which is the CBOE Volatility Index. The VIX is now near the levels it was headinging into the early February rout on the index. Typically, when the VIX rises, prices are in danger of falling due to heaightened volatility.

While its broadly true that the VIX levels are similar, the trend now and the trend in January before the February correction are actually quite different.

 

visual by Jason Pfaff

 

The build in January up to the downward move in February was much steeper as a trend. The VIX had been lower, and moved up to about the level we are now. Conversely, currently we are ranging around the same level we were when we started the month of August, and while the is more movement back and forth on the VIX, the overally trend is fairly flat.

Lately, the more serious trend is that the VIX has been inching up in the short term, while the trend for the index was moving up as well. Typically, if volatility is increasing while an index is moving up, that can indicate a trend nearing exhaustion and a reversal is possible. At its simplest, volatility is an indication of a market in disagreement. If a market is increasingly in disagreement in an uptrend, that could signal a new direction is near.

As volatility increases, a potential strategy is known as a binary strangle. In this scenario, a trader with conviction that there was going to be an increase in volatility would buy a binary above the current market, and sell an option below the market. The risk would be what is paid for both contracts, and the reward could be one or both contracts becoming profitable if the market is volatile enough.

 

Looking ahead on the S&P 500

 

We do see a reasonable probability that a pullback to roughly the 2850 level is possible on the S&P 500. We developed a forecast model indicating a potential track and trajectory for the index in weekly values over longer periods of time.

Ultimately, we see a basis to expect some level of pull back in the next 3-6 weeks before resuming a push higher to end the year.

 

analysis and visual by Jason Pfaff

 

Of course, many things could directly impact markets in the meantime. As trade wars heat up, interest rates potentially rise and global growth possibly slows, we could see a steeper pick up in volatility and a deeper and longer term decline in the index. 

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