Market Outlook VIX Sounds All Clear For Stocks Bernie Schaeffer, Option Advisor 10.08.07, 11:30 AM ET Related Stories Building Green Gurus Jump Into IT VIX Tumble Spurs Stocks Fifty Or We're Falling Hard Financials For The Holidays CINCINNATI, Ohio - The broad market continued to rally last week despite ongoing concerns about weakening economic conditions, subprime woes and earnings warnings from a number of banks. Which recent major winners are due for a pullback of 20% or more? Lock in profits or get in on the short side with trades in Option Advisor. The tech-laden Nasdaq Composite jumped 2.9% last week, hitting a six-and-a-half-year high. Elsewhere, the Dow Jones industrial average charged 1.2% higher, while the S&P 500 Index gained just over 2%; both indexes tagged new all-time highs during the week. Furthermore, the S&P 500 finally closed above the 1,553.11-level, which marked the March 2000 high for the index. The Russell 2000 Index sprinted nearly 5% higher last week, moving firmly above former resistance at the 800-level. The index's next major challenge from a chart perspective is the 850-level. This region, which is now only 0.61% above the index, halted the index's rally in June and July. Special Offer: Make big gains in bull and bear markets. Although it can be nerve-wracking, you can profit handsomely from price declines if you own puts. Which stocks and ETFs are most likely to slip most? Click here for recommended trades in Option Advisor. However, the small-cap sector could receive a significant lift from the continued unwinding of bearish sentiment. With only a small percentage of hedge fund managers bullish for September, and only 5% of hedge fund managers in a recent survey proclaiming themselves bullish for the month of October, it wouldn't surprise me if many have positioned themselves net short the small-caps. After all, the Russell 2000 Index has tended to take it on the chin more so than larger caps during the various corrective phases in the market we have seen in 2006 and 2007, and many hedge funds have reined in their risk profile. But should the small-caps continue to lead the way as they did last week, we could see some hedge funds take a major hit from a repositioning that was actually designed to reduce their downside exposure. Furthermore, as they unwind their shorts on the small-cap sector, the increase in buying pressure will help to lift the group even higher. One key component needed to put this rally on solid ground would be for the Russell 2000 to begin to seriously outperform the S&P 500. This would blow away the "bad breadth" concerns, as well as discredit the comfortable consensus that "safety in the form of large-cap U.S. multinationals is the place to be." I would very much like to see the Russell 2000's relative-strength measure vs. the S&P reverse into a sustained uptrend. Keep in mind that this measure's rally was quite tepid off its first-quarter bottom before just imploding in July, a signal that trouble was just ahead. Another key component to helping keep uptrend on solid ground could be the CBOE Market Volatility Index's close this past week below its 32-week moving average. I believe the VIX close below this trendline last week could have very similar implications to that of Aug. 2006, which, in hindsight, signaled an "all clear" for stocks during the final months of that year. I'd like to see additional VIX weekly closes below the 32-week average to accentuate the contrast to the period following the March 2007 bottom, when the VIX pullbacks following the spike in February and March did not penetrate below the 32-week moving average, which signaled trouble ahead. Special Offer: Invest like the legends--Graham, Buffett, Neff, Lynch and others. The Validea Hot List takes the best current picks based on the strategies of the world's greatest investors of all time. The portfolio has returned 175% since July of 2003 vs. 52% for the S&P 500. Click here for the complete list of current buys. What's more, the VIX generated a signal on Oct. 5 when it dropped by less than 10% (specifically, 8.3%), while the S&P rose by more than 0.85% (it gained 0.96% during the session). This phenomenon--with the S&P rallying more than 0.85% while the VIX drops less than 10%--has had historically bullish implications dating back to 1990. Specifically, after 20 days, the market is higher 69% of the time; the average gain in the S&P over this period is 1.65%. As we head into a new week, we are faced with the official start of a new earnings season. The impact of credit and liquidity concerns as well as continued problems within the housing sector are widely expected to weigh heavily on third-quarter earnings. As a result, the consensus estimate for earnings growth has been sharply lowered from roughly 6.2% in July to a gain of 3.8%, according to Thomson. The earnings growth rate expected for the S&P 500 Index has dropped even further, to 1.4% for the quarter, which would effectively be the worst performance in more than five years. These sharply lowered expectations leave the door wide open for positive surprises across the Street, which could keep this rally alive throughout the next couple of months. Also weighing on the market this week will be the Federal Open Market Committee minutes from the latest meeting. This report will be thoroughly dissected by analysts for possible clues as to what the Fed will do at its meeting at the end of this month. In addition, September retail sales are due out at the close of the week, which could give a good look at the health of consumer spending.
If the russel breaks down again I think the overall market could be looking towards a 3-5% dip. If the russel breaks out the other indexes should have nothing to worry about.