The SPX to VIX ratio indicates SPX will be much lower within a month (see last week's article "Will the Cyclical Bull Market End in 2006" for more information on volatility ratios). However, over the next week or two, SPX may stay high, because of end of the year window dressing, new money at beginning of the year, and the start of earnings season in early January.

The first two charts below are same period daily year-to-date charts of the SPX to VIX ratio and SPX. The ratio closed above 123 Friday, which is an all-time high. Consequently, SPX is severely overbought, and on the verge of a steep pullback or correction, since the ratio is mean-reverting.

SPX rose above and held the 20-day MA throughout the recent two-month rally. However, last week, it closed below that MA. Consequently, a level just below the recent high at 1,276 is resistance, i.e. around 1,270. The next two weeks is a seasonally bullish period. So, the possibility of SPX rising to its upper weekly Bollinger Band or the upper line of the rising wedge, both around 1,285, should be taken into account.

Major support is 1,246, i.e. previous four-year high. If that level fails, then the middle of the (rising) weekly Bollinger Band, currently at 1,230, is next major support. There are many minor support levels, including several open gaps. However, the third chart suggests when SPX closes below the middle of the monthly Bollinger Band (which is also the 20-month MA), currently just above 1,180, then the cyclical bull market will be over.

Economic reports next week are: Wednesday--Consumer Confidence, and Thursday--Unemployment Claims, Existing Home Sales, Chicago PMI, and Oil Inventories. Financial markets will be closed Monday, December 26th. The final trading day of the year is Friday, December 30th. Also, markets will be closed Monday, January 2nd.

Over the first two days of January 2005, SPX fell over 30 points, from 1,218 to 1,186, and was in a general downtrend, until late January, hitting a low at 1,163. There may be a similar fall next month. However, the SPX to VIX ratio is much further above the 200-day MA, which may indicate a more severe downtrend. Consequently, SPX could fall to the (rising) 200-day MA, currently about 1,210, in a month.

Charts available at PeakTrader.com Forum Index Market Overview section.

Arthur Albert Eckart is the founder and owner of PeakTrader. Arthur has worked for commercial banks, e.g. Wells Fargo, Banc One, and First Commerce Technologies, during the 1980s and 1990s. He has also worked for Janus Funds from 1999-00. Arthur Eckart has a BA & MA in Economics from the University of Colorado. He has worked on options portfolio optimization since 1998.

Mr Eckart has developed a comprehensive trading methodology using economics, portfolio optimization, and technical analysis to maximize return and minimize risk at the same time and over time. This methodology has resulted in excellent returns with low risk over the past four years.

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