Traders are still reeling a little from this week’s disruptions. Tensions created by North Korea’s nuclear tests will probably be a recurring issue into the third quarter, and geopolitical uncertainty is being compounded by greater-than-expected damage from hurricane Harvey and hurricane Irma, which is currently heading towards Florida.
But how stressed are traders really? We know that many of the “hurricane trades” — home improvement, gas, insurance, etc. — are likely to unwind, which should add to short-term volatility. However, the major indexes aren’t showing many other signs of stress, and the decline on Tuesday appears to be superficial at best.
Two measures of investor stress include the CBOE Volatility Index (VIX) and CBOE SKEW Index (SKEW). Each of these indicators evaluate expectations based on the price of the options on the S&P 500 cash index. As you can see in the chart below, the numbers aren’t great (higher readings = more stress and uncertainty), but neither index is challenging new highs.
CBOE Volatility Index, VIX (Blue) versus CBOE Skew Index, SKEW (Red)
We don’t want to be misunderstood as suggesting that just because investors aren’t maximally fearful that there is large potential upside. Instead, the evidence seems to be pointing towards a flat market more than a breakout in either direction.
The market is likely being held back by growth expectations, which remain low after a brief respite in June. One way to measure growth expectations is by comparing the yield curve (Treasury rates over different maturities) today to its shape in the recent past. The next graph illustrates the depth of the yield curve by comparing the 2-year Treasury yield to the 10-year Treasury yield. As you can see, the trend is in decline and has nearly erased all of June’s gains.
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity
The Bottom Line
The market looks channel-bound for now. We believe that traders are unlikely to break higher until the U.S. debt ceiling fight is over, which could extend until the end of September. There are some promising signs of fundamental strength for next month’s earnings, but that is not attracting much interest from investors yet. On the bright side, there also don’t seem to be many catalysts for additional downside. Buying the dips with moderate expectations to the upside is likely the best strategy for bullish positions.
You can learn more about identifying price patterns and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next SlingShot Trader trade and get 1 free month today by clicking here.
Most recently, John and Wade are co-options strategists of Turbo Trader Live — a live, interactive trading room service that runs two hours every trading day the market is open. Turbo Trader Live focuses on long call and put options, as well as long and short vertical spread strategies. Find out how to get in on the live trading action and start making real profits by clicking here.
