foxex: Volatility Drop

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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Wednesday, August 05, 2020 Headlines

1. Stocks head for new highs as volatility measures fall

2. Tech on top with discretionary close behind

3. Ready for some football?

Market Moves

Stock indexes continued to rise with gains today shifting from tech stocks to consumer discretionary companies after Disney (DIS) reported favorably. Yet another bullish signal occurred today as volatility measures made a significant new low. The CBOE Volatility Index (VIX) broke support and closed at its lowest level since the pandemic crisis began.

The chart below compares the S&P 500 index (SPX) with the VIX. The key insight from this comparison is the last three days. Notice how the S&P 500 had cleared its most recent high three days ago, but the VIX has had difficulty coming down below its corresponding support line. This depicts how option sellers are still clinging to a bit of risk pricing, as if they were concerned about stocks falling in the near term. But this new low on the VIX seems to begrudgingly concede that stocks are likely to go higher from here.

Another point to make is that this dynamic is primarily driven by the demand for put options. If the VIX makes a new low it implies that option buyers are less fearful for price drops in the near term. Either way, it is a bullish indication.

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Tech on Top with Discretionary Close Behind

If stocks are beginning to broaden their rally beyond the technology sector, it is useful to see which sector is showing the next highest degree of relative strength. The chart below depicts State Street's sector ETFs and highlights those two tracking the Technology sector (XLK) and the Consumer Discretionary sector (XLY). Oftentimes if one sector has led for a month or more the better returns come in the next quarter from the sector in second place.

This likely happens because many individual investors and portfolio managers don't like the idea of buying stocks at their highest point. They prefer to look for stocks that represent a better opportunity according to well-known valuation metrics. When looking at a relative-strength comparison of sectors, choosing stocks from the second place sector can be an effective technique for quickly identifying a great opportunity.

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Disney Earnings: What Happened

Ready for Some Football?

The chart below gives a quick look at a pattern that may be ready to form on Disney stock (DIS). The formation, known as a cup-and-handle pattern, is as yet incomplete. Chart watchers know that a half-formed pattern may not result in a pattern at all. The hidden dynamic behind this price action is the press of investors looking for opportunity in the Consumer Discretionary sector and the seasonal timeliness of the onset of football season in the U.S. It is not widely recognized among casual investors that Disney actually makes more money from football-related revenues than any other segment of its company.

There is no doubt that fans will have a muted response to the sport during pandemic-imposed conditions, but most analysts anticipate this. That idea harks back to how things played out in the last earnings announcement. Analysts had expected the company to report a significant loss for the second quarter, but the mouse surprised everyone by delivering the cheddar. It may be that the company is capable of outperforming already low expectations for the third quarter. If so, or even if investors begin to suspect this possibility, the price dynamic needed to complete this pattern could easily fall into place over the next two weeks or so.

The Bottom Line

Stocks rose and volatility fell signaling the possibility that the upward trend in the markets could continue. Stocks in the Consumer Discretionary sector appear to be catching the eye of investors right now. Among those, shares of Disney appear to be setting up with a bullish pattern.