As we have mentioned in the past, each time that the market has faced a major financial debacle, we have witnessed a ramp-up in major indices' volatilities followed by a Volatility Re-Test, as measured by intensity (sigma levels). This is a must prerequisite for markets before they can resume their normal operations.
This Fed, led by the very able Dr. Ben Bernanke, has pumped in near $85 Bils in 3-day repos this week, buying MBS and Treasuries, in an effort to provide short term liquidity. We are still holding our Short SPX position from June 7th (1490.72). We do not think all the bad news is out yet. This week market actions reminds us of August '98 before the LTCM debacle with same pattern of massive volume on alternating large range days (positive and negative bars).
We have included two charts here. Timer Chart shows a short-term oversold condition with no immediate stabilization in sight as we enter August Options X week. The McClellan Oscillators for Advance/Decline and Up/Down Volume closed in negative territory on Friday even though indices closed mix.
The next chart shows the popular Vol Indices overlaid with sigma channels. This is the set-up part of the vol retest and we suspect the next 3 to 4 weeks will be very challenging trading environment till we go thru the vol retest. Our down-side target on the Dow is 12,500 and then 12,000.
We suspect the next shoe to drop won't be another sub-prime woe, rather it will be an exogenous news and if we had to pick it, it could be Perviz Musharraf getting booted out of Pakistan. That would give this market the badly needed wash out via a massive volatility retest and create for us a tradable low.
Do not buy dips -- rather SELL THE RALLIES..........