Sam Collins

Vexed by the VIX

by Sam Collins   10/17/08

The Dow Jones Industrial Average (DJI) reversed sharply Thursday and, after being down almost 380 points in the morning, was able to complete a better than 800-point swing and close higher by just over 400 points.

It was a dramatic turn from Wednesday's selling and was made in the face of declining oil prices (crude fell under $70 a barrel) with the energy sector actually leading the advance and in contrast to a sharp decline in the sector just the day before.

The real cause of the advance wasn't clear except that, technically, the market was overdue for a rally, and the CBOE Volatility Index (VIX) hit a new high above 80 in the morning before the rally began.

Economic news was mixed. On the positive side, filings for jobless claims declined 16,000 to 461,000, which was below expectations. But industrial production for September fell 2.8%, which was worse than anticipated.

Airlines did well yesterday due to the fall in the price of oil, with Southwest Airlines (LUV) and Continental Airlines (CAL) announcing better-than-expected earnings. And even laggards United Airlines (UAUA) and US Airways (LCC) had a strong day.

Financial stocks lagged but others that had lower earnings still made solid gains.

Nokia (NOK) reported a 30% profit drop but the stock was up 9.7%, and Harley-Davidson (HOG) had an earnings decline of 37% but the stock gained 7.4%. However, conglomerate United Technologies (UTX) topped earnings expectations and gained 7.37%.

At the close, the Dow (DJI) was up 401 points to 8,979, the S&P 500 (SPX) gained 39 points to 946 and the Nasdaq (NASD) rose 89 points to 1,718.

The New York Stock Exchange traded almost 2 billion shares, with advancers ahead of decliners by more than 2-to-1. On the Nasdaq, almost 1.6 billion shares crossed and breadth there was also positive by 2-to-1.

The November crude oil contract fell $4.69 to $69.85 a barrel, the lowest price since late August 2007, and the Amex Energy SPDR (XLE) gained $1.65 to close at $44.95.

The December gold contract fell to $804.50 per troy ounce, off $34.50, and the PHLX Gold/Silver Index (XAU) fell $6.84 to $88.32.

What the Markets Are Saying

Fear readings hit record numbers again Thursday, with the CBOE Volatility Index (VIX) reaching a new all-time intraday high of 81.17.

This would normally be considered a positive indicating that the market is in a final purging phase which could soon result in a bottom. But one of our favorite sentiment indicators, the American Association of Individual Investors (AAII), suddenly flipped from all-time high bearish to bullish -- and that non-confirmation is disturbing.

Non-confirmations often lead to a resumption of a downtrend, and so this is something to keep an eye on.

After such a resounding sell-off, yesterday's reversal might give us a solid bear market rally. And with a lack of resistance immediately above current prices as a result of the one-week free-fall, this rally could have some spring to it, especially if it's not just the product of expiring options today.

No real resistance occurs until S&P 500 (SPX) 1,100 to 1,200 and there isn't serious work until the 1,200 to 1,300 level.

In other words, there is a lot of room for a string of advances and declines within a broader range that could even lead to a reversal pattern similar to the triple bottom of 2002 - 2003.

But the switch in AAII sentiment is of concern, and so if the major support provided by the triple bottom of the last bear market at SPX 768 to 960 with its head-and-shoulders target of 864 doesn't hold, watch out. The next support doesn't show up until around 600 to 680.

And one further note: Today, options expire and so anything can happen -- traders should use caution.

Today's Trading Landscape

Earnings to be reported include: Adams Express (ADX), Amcol Int'l (ACO), Aracruz Celulose S.A. (ARA), Comerica (CMA), Eastern Virginia Bankshares (EVBS) and First Horizon National Corp (FHN).

Genuine Parts (GPC), Honeywell (HON), iGate Corp (IGTE), LaBranche & Co (LAB), Prosperity Bancshares (PRSP), Satyam Computer Services Ltd (SAY), Schlumberger (SLB), Sensient Technologies Corp (SXT), Sonic Corp (SONC), VF Corp (VFC) and Wilmington Trust (WL).

The following economic reports are due: September housing starts (the consensus expects negative 1.1%) and the Mid-October Reuters/University of Michigan Sentiment Index (the consensus expects 65).

Chrysler and General Motors (GM) are accelerating merger talks. The euro zone's trade deficit rises sharply. Microsoft (MSFT) is playing down recent comments by its chief of a deal with Yahoo (YHOO).

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