Positives in This Ugly Market

While the usual trend-followers and momentum players will now be running for the exits after buying the recent "breakout" above 1300 in the S&P 500, there are reasons to be looking at the market as glass-half-full, rather than half-empty (or completely empty) at current levels.

Granted, the market has cracked recent support, pretty much across the board. But that break of support had several silver linings.

First, we needed a breakdown to turn the crowd negative (again) after all the complacency, which was evident during the advance off the July lows. The chart of the VIX below makes the case pretty clear, once again, that when this indicator dips below 20, that is not bullish in the least.

As I noted in last week's column, when I explained that I was selling into the rally, "the sentiment picture was also not conducive to a further rebound, as the VIX was back below 20." Since then, the market has collapsed and the VIX has popped back above 24.

Granted, we have seen the VIX spike to the mid-30s. At the July lows, the VIX topped out at 30.81. So it can certainly go there or higher. If the July lows now give way, it probably will.

CBOE Volatility Index (VIX) More bullish now than before

Click here for larger image.

Source: OptionsXpress

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Second, the break of support helped to relieve the overbought condition that was still (stubbornly) in effect through Wednesday's close (according to the McClellan Oscillator). That has now been addressed, as the oscillator finally returned to the neutral zone on Thursday at -0.5, which is about as neutral as it gets.

Third, the negative action has led to a collapse back toward the July lows, and in some indices like the Nasdaq 100 (NDX), even lower lows. In the case of the SOX, the Philly Semiconductor Index, we've seen new multiyear lows. If you are wondering what's so good about a return to the July lows, these levels in the major averages mark multiyear lows and, accordingly, represent the most important support levels of this year. From my perspective, that makes them ideal levels for buying -- at least for a rebound.

Let's take a quick look at some of these indices that have pulled back to the July lows, and some that are holding well above their respective lows.

S&P Futures Floodgates opened on a break of support

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Source: Lind Waldock

First, the S&P, which was probably the major culprit in Thursday's meltdown. While the commentators in the gee-whiz financial media scratch their heads at yesterday's shakeout, looking for fundamental causes to explain the plunge, a simple look at the chart of the S&P tells the tale.

The 1261-1263 level that I have been talking about for weeks was the obvious line in the sand, and yesterday, it gave way. The market sold off as that support cracked and sell stops got triggered under the lows, and from there sell programs followed. That's pretty much all it was. The rest is just noise.

In the process of that plunge, some downside gaps were filled or almost filled. First, there was the Aug. 5 gap from 1257.70 down to 1248.80. Then late in the day, the S&P almost filled its July 29 gap at 1235.10. It bottomed at 1235.20 in the final minutes, and it looked like maybe that was close enough. But this morning, the big gap down opening followed the jobs report, and now we have hit new multi-month lows just 16 points from the multiyear July lows at 1201.00.

For now, it is not clear that the low is in. But if that 1201 area is revisited, I will add to my positions in the S&P. Already today I have added to some bullish option positions.

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Nasdaq 100 (NDX) New multimonth lows

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Source: Lind Waldock

As noted above, the NDX has also hit some big numbers. It has now made new multi-month lows, taking out its July lows of 1761. Keep in mind that here, the July lows are well above the March lows of 1669. So the July lows aren't the most important support here, and the break of this level may point to a further collapse to the March lows.

That's not the most bullish-looking pattern, but it does suggest a bounce; perhaps that bounce off today's lower lows at 1740 is under way. I was a buyer of NDX mutual funds at yesterday's close and will add to those positions if the 1670 level is revisited.

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Russell 2000 Bottoming at the Aug. 5 gap

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Source: Lind Waldock

A very different, and ostensibly more bullish, pattern is seen in the Russell 2000, which is still holding well above its July lows at the 647 level. Note that the selloff into today's low around 703 has led to the filling of the Aug. 5 gap at 704. That also could signify that we have seen enough of a drop for now.

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Financial Select Sector SPDR (XLF) Holding well above recent lows

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Source: OptionsXpress

But perhaps the most bullish of developments is seen in the action of the financials. I continue to be long the Financial Select Sector SPDR (XLF - commentary - Cramer's Take) ETF (at Rydex) and also holding bull spreads in the UYG calls, the Ultra Financials ProShares (UYG - commentary - Cramer's Take). Here it is noteworthy that the decline into this morning's lows of $20.63 in the XLF is a long way from the July multiyear lows of $16.77. I am not adding to positions at current levels, but I am still holding my positions.

More to the point, I view this potential nonconfirmation at the lows as bullish for the overall market, as this group was the leader on the downside and is now one of the strongest sectors.

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At the time of publication, Schiller was long Financial Services, SPX, NDX, and Dow mutual funds up to 75% levels; long bullish option positions in the QQQQs, DJX and UYG calls, although holdings can change at any time.

Dr. Harry Schiller is a Registered Investment Advisor with the California Dept. of Corporations. He holds a Series 7 General Securities license as well as a Series 4 Options Principal license. He has been owner and editor of the Short Term Consensus Hotline since 1988. For more information, see www.harryschiller.com. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.