A Bear Market in Bearish Trades

In my article last week, “VIX Withers Down Below Technical Support After Huge Job Loss Catalyst ”, I described the capital markets as consisting of four lily pads, each of which comprising stocks, bonds, commodities, and “bearish trades”, respectably. I went on to equate traders and investors with a herd of frogs, leaping in droves from one lily pad to the next. I went on to conclude that a preponderance of frogs has crammed onto the stealthy “bearish trade” lily pad, to such an extreme that it’s starting to look like something there is beginning to give way. I emphasize the word “beginning” because a frog stampede is an organic process, not a snapshot in time.

Where do we stand in this process? The answer is that this week, we’re seeing some technical evidence that suggests the exodus from the stealth lily pad is gathering some momentum. When we last visited the CBOE Volatility Index (the “VIX”), we saw it nestled, somewhat tenuously, just above its 50 day exponential moving average (the “50 day EMA”). In the context of a strong bull market on the VIX (or, indeed, many other tradable assets), the 50 day EMA often acts as technical trading support. When the VIX fails to observe technical support at key area (such as the 50 day EMA), it’s not doing what it usually does when it’s in a bull market, which calls into question whether it is actually still in a bull market.

Last week, in the face of what should have been a huge catalyst for a rally on the VIX, the VIX dithered and ended lower. But this week, after a brief rally on December 9th sort of petered out, the VIX plunged below its 50 day EMA, which failed to act as technical trading support. Then on Friday, December 12th, word came in before the start of trading that the Senate had rejected a bailout of the US automakers. Not surprisingly, markets across Asia reacted like a toddler suddenly deprived of a favorite toy. Futures on the US markets indicated a sickening drop. In a nutshell, the VIX was primed to spike up higher. And sure enough, as the US equities markets tanked within minutes of the opening bell, the VIX headed higher, ultimately clearing the 50 day EMA. It was looking promising on the stealth lily pad for a while, but notwithstanding the strong catalyst for a higher close, the VIX petered out… again… closing moderately lower.

And why does this matter? It matters because not only has the 50 day EMA failed as trading support on the VIX, it is increasingly star (click to enlarge):

What you are typically seeing when technical trading support transmogrifies into technical trading resistance is a change in the price trend. The ascent of the VIX is fueled by nasty economic or market news, and while that news has been pouring in of late, it hasn't kept the VIX from slipping into a near term, downward trend. Traders care about technical trends, and are quite proactive when it comes to positioning trades that go along with (or at least do not go against) a potential stampede. From a technical trading standpoint, a stampede seems to be brewing.

Again, asset pricing is an organic process, but if this particular organic process keeps up, we may be at the front end of an intriguing oxymoron: a bear market in bearish trades.

Disclosure: no positions

Comments

[leh:]

OTOH the financials rolled over last week and the so-called rallies looked either weak or like short-covering, fast money flip trades rather than real accumulation.

2008 Dec 15 09:14 AM