I expect volatility to increase this week, particularly with VIX options expiring on Wednesday. The current VIX option positions suggest that the VIX may remain around the 15 level, which means the reduction in volatility that helped last week won’t be a factor this time.
Additionally, as the market drops, we won’t have the support from the decaying S&P 500 put options that traders rushed to buy back in early August, with monthly OPEX now behind us. If the market rises this week, it will need to do so on its own merits, without the tailwind of options expiration.
Additionally, 1-month implied correlations dropped further on Friday, now sitting at 10.6 (this is a measure of how much different stocks move together).
This level is typically associated with market tops, and while it could go lower, it suggests caution when chasing rallies. Just a month ago, this indicator proved useful in identifying the July peak, so it’s worth keeping an eye on it as a potential signal.
Additionally, the S&P 500 30-day realized volatility is at 20.16, while the VIX is at 14.8, creating a difference of +5.36. Historically, this kind of gap (where actual volatility is significantly higher than expected volatility) hasn’t happened often.
When it does, it’s usually followed by more volatility and further drawdowns in the S&P 500. This pattern typically occurs after a big move down, then a big move up, followed by another move down. Looking back to the year 2000, this scenario has happened several times, and in most cases, it led to increased volatility.
However, there were two notable exceptions after the December 2018 and March 2020 sell-offs.
This week will be important for the Japanese Yen, with BOJ Governor Ueda speaking before Parliament on August 23. Additionally, on August 22, we’ll see the release of the CPI, which is expected to show a 2.7% year-over-year increase, slightly down from 2.8% last month.
The USD/JPY has returned to its 20-day moving average, indicating that it is no longer oversold, and it has also dipped below the 10-day exponential moving average as of Saturday. This brings the key support level back to 146.25. If this support is broken, it could lead to a retest of the lows around 142.
Meanwhile, the S&P 500 reached the 78.6% retracement level (a key technical level that often signals a potential reversal or continuation of a trend) of the decline from mid-July. If the index is going on to make new highs, then this is the level it needs to break through for that to happen.
Additionally, the index has returned to retest the trend line (a line that connects two or more price points and shows the general direction of the market) that formed off the October 2023 low. This makes the area from Friday’s close a strong level of resistance (a price level where the stock or index may struggle to move higher).
Additionally, we have good wave balance in place (a situation where different waves in Elliott Wave Theory are proportionally related), with wave five equal to 61.8% of wave three, wave three equal to wave one, and wave five equal to 61.8% of wave one.
So, from a Fibonacci perspective (a method of technical analysis using key ratios like 61.8% to identify potential reversal points), one could argue that the highs seen in July are significant, and the rebound from a Fibonacci standpoint has been a retracement (a temporary reversal in the direction of a stock’s price within a larger trend).
The index stopped at the point of a gap fill (the price level where a gap in the chart, usually caused by a sudden price movement, gets “filled” by the price returning to that level), an area that has been important since early July.
I’m not saying it’s exactly the same, but it is similar to what happened in the fall of 2018. We saw a sharp sell-off of nearly 12%, followed by a quick rebound of over 8%.
In the fall of 2018, there were also growth concerns as economic data began to reflect the impacts of the trade war and a Fed that wasn’t acting quickly enough to cut rates. This eventually led to the December 2018 meltdown when Jay Powell was less experienced. It’s definitely something to keep an eye on.
From a purely mechanical standpoint, I believe this week will be tougher than last week. Technically, there appear to be more resistance levels, so if the market is going to pull back, this week offers the best chance for a reversal. If not, we should know pretty quickly.