June Option Advisor: A Look at the Technicals

The following is a reprint of the market commentary from the June edition of the Option Advisor, published on May 27. Prices and the charts are as of the close on May 27. For more information or to subscribe to the Option Advisor, click here.

At my Las Vegas Money Show presentation earlier this month, I focused on two moving averages I was keying on as indicators of the market's health in the wake of the flash crash decline and its aftershocks.

1. The S&P's 160-month moving average - This long-term series was very significant as support at the 2002-2003 lows and once it was broken in October 2008 a downside cascade ensued. I indicated that it would be a big plus for the market if this level could be retaken by the last trading day of May, but with tomorrow being the final trading day of the month, this appears to be unlikely even after today's furious rally. The S&P closed at 1,103 today while the 160-month is at 1,167.

2. The S&P's 200-day moving average - Unlike the 160-month, a glacially "slow" moving average that is essentially a creature of the technical analysis toolbox at Schaeffer's, the 200-day moving average is very widely followed by everyone from market technicians to amateur traders and even by many fundamental analysts. While I would therefore never want to initiate or close trades based on this moving average (the tool is "too crowded"), it is of not inconsiderable psychological significance for the market to successfully navigate back above this level because of the widespread agreement that it is an indication of its health. The S&P's 200-day is just 5 points above today's close of 1,103.

This all said, I consider the health of the Russell 2000 Index (RUT) to be of even greater importance than that of the S&P, because the strength of the rally off the March 2009 bottom has been very much concentrated in the smaller cap space. And a breakdown in the leadership area of the market is likely to have heightened negative implications.

The accompanying chart of the RUT over the past two years, along with its 80- and 160-day moving averages, is very enlightening in this respect. Note the rallies in January and February 2009 that were soundly rejected right at the 80-day moving average and were preludes to the big plunge into the March 2009 bottom. And on the post-March 2009 rally, all pullbacks in the RUT have thus far been contained at the 80-day, and any downside penetrations have been brief in time and/or shallow in price. The RUT closed today at 670, just 4 points below its 80-day moving average, and it would be very encouraging to see a quick move back above this level as a confirmation of an ongoing uptrend that was interrupted but is still intact.

The RUT's 160-day moving average contained the February 2010 pullback and has thus far contained the May pullback, with today's rally adding to the credibility of this level as support. Note also that the flash crash plunge on May 6 bottomed just 3 points above the 160-day.

An exchange-traded fund (ETF) chart of great interest is that of the iShares Lehman 20+ Year Treasury Bond (TLT), a measure of U.S. government bond performance. Note the recent spikes by TLT on the accompanying chart to the extremely important $100 level, and the subsequent severe rejections at that level, the most recent of which occurred today. Bonds and stocks have been moving in inverse fashion for quite some time now, with bonds being considered the "safe assets" to which investors flock when they're fearful. Along these lines, note that TLT trading volume on several occasions this month was the highest in the entire four-year period encompassed by the chart, comfortably exceeding volume during the 2008-2009 TLT price spike that was related to the financial crisis and the stock market panic over that same period. This huge TLT volume spike strongly suggests a level of fear among investors disproportionate to the relatively minor extent of the stock market pullback, which would suggest to me and other contrarians that a stock market bottom may well have been put into place this month.

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