Submitted by Tony Pallotta of Macro Story
Where Are The Markets Headed Next?
Being honest, no one knows. But, using the current road map it appears we may have a little more selling before a decent move higher. Below is the updated 2007 "analog" as compared to the current market. Few interesting points.
The move in 2007 from Point F to the next low was 15.3%. The market then rallied 10% before another leg lower.
The current move from Point F to the current low is 11.1%. Interesting a 15.3% move from Point F would bring the SPX to 1,143 which is the rough target of the head and shoulder's pattern and where key support levels come into play.
At some point this market will rally and will rally hard. Remember there are a lot of participants who view this selloff as excessive and based on fear. They view the macro data as a soft patch and see the Fed ready to launch QE3. When this market rallies they will be very loud in their "I told you calls." Many shorts with conviction after a day or two of market strength will in fact panic and begin to believe in the health of the economy contrary to what they know in their heart.
When studying the 2007-08 chart remember Bear Stearns was "bailed out" by JPM in March 2008 which caused a multi month rally that preceded the epic selloff.
My personal view is we are headed for a similar epic selloff. I'm not sure when but suspect it is sooner than most think. BAC breaking down could very well be the modern day LEH failure. We are surrounded by "black swans" right now from rumors of Italian run on the banks to failed Spanish auctions and more.
Vix Skew Divergence
The skew continues to move lower while the vix moves higher meaning volatility is more evenly distributed and "black swan" events are less of a concern among investors. Still based on historical levels the all clear signal for equities is unclear. Below are two charts (1) short term chart that looks like more selling is probable and (2) long term chart to put the current levels in perspective.
I wish I could be more definitive in terms of where markets are headed next based on this signal. Probability would say further selling based on divergence and the 2007 pattern but this market is emotionally charged with lots of leverage. A dangerous combination. Be careful out there, respect stops and don't be a hero.