Breakeven Levels for the Stock Market

The Dow Drops Below Breakeven Levels for 2012!

The Bulls -- Technical Support Areas Remaining – All Is Not Lost!

Will Major Indexes Continue to Fall?

by Ian Harvey

breakeven levels

June 04, 2012

Introduction of Breakeven Levels

Traders emerged from the holiday weekend refreshed, rested, and ready to trade. Unfortunately, the buying campaign that powered the markets higher on Tuesday was a distant and bittersweet memory by the time Friday's calamitous session rolled around – which is discussed more graphically in “The Week Ahead in the Stock Market - June 04, 2012”.

The seemingly never-ending plague of worries from the euro zone teamed up with disappointing numbers on domestic soil to send the Dow Jones Industrial Average (DJIA) into the red for the year. All may not be lost for the bulls, however, as some remaining technical areas that could serve as significant support against an increasingly skeptical sentiment backdrop surrounding the breakeven levels, are still apparent.

The definition of “Breakeven Levels - BEL” in general terms, is the points at which gains equal losses. This amount of money for which an asset must be sold also must cover the costs of acquiring and owning it.

In options, the breakeven levels are achieved -- when the market price that a stock must reach for option buyers to avoid a loss if they exercise.

For a call, it is the strike price plus the premium paid.

For a put, it is the strike price minus the premium paid.

Breakeven Levels and the Mindset

.....Even if the 320-day moving average is taken out -- the bears would likely be challenged by other longer-term support areas -- namely in the 1,240-1,280 area. This area represents the SPX's year-to-date breakeven (1,257), and is home to other long-term moving averages that have acted as support and resistance on pullbacks over the years -- most notably, the 80-week and 80-month moving averages, perched at 1,287 and 1,240, respectively.....”

“.....the sentiment backdrop at present is one that usually marks important bottoms. Therefore, the SPX low at 1,291 support during expiration week, the PowerShares QQQ ETF (Nasdaq: QQQ) pullback to its half all-time high in the 60 area, and the Russell 2000 Index’s (RUT) pullback to its 2012 breakeven and the 750 area -- site of the peaks ahead of the Lehman Brothers crisis in 2008 and "flash crash" in 2010 -- argues for a bottom being in place.....”

“.....with the SPX trading below 1,333 (the March 2009 double-low) and 1,340 (resistance in 2011), the bulls are not yet out of the woods. And as an added risk, the CBOE Market Volatility Index (VIX) remains above 20.49 and 21.36, which are 50% above the intraday and closing March lows. Up until recently, this area provided resistance, but acted as support this past week.....”
- SPX Volatility, May 29, 2012

It may go without saying that the technical backdrop deteriorated this past week, especially after Friday's drubbing -- ignited by an employment number that came in far below expectations -- fanned worries that our economy has hit an abrupt slowdown. This report came in as credit issues continue to fester in Europe and emerging economies (such as China and India) show evidence of slowing down after previously growing at a blistering pace.

Technical Notes for Breakeven Levels Analysis

As we head into the week’s trading, here are some technical notes of interest that might be useful in preparing for the weeks ahead and assessing breakeven levels effects:

1. The Standard & Poor's 500 Index (SPX – 1,278.04) dropped below 1,290, site of the index's 320-day moving average and a 38.2% Fibonacci retracement of its October low (1,074.77) and April peak (1,422.38). This breach followed Tuesday's failed attempt to push above 1,333, double the 2009 low on the index and a level we viewed as important for bulls. The drop below 1,290 leaves the market vulnerable to more selling, although as mentioned last week and excerpted above, there are other areas of potential support in the 1,240-1,280 region, which could save the day for the bulls after a disappointing failure to hold 1,290.

2. The Dow Jones Industrial Average (DJIA – 12,118.57) moved into negative territory for the year last week when it fell below 12,217.56. Year-to-date breakeven levels for other key benchmarks are listed below and could serve as pivotal levels in the week or weeks ahead, if more selling persists:

breakeven levels1

3. The Russell 2000 Index (RUT – 737.42) peaked last Tuesday right at its 320-day moving average in the 780 area. This moving average is now rolling over, which is an ominous sign. The failure at 780 was followed by a break below 750, a key level that marked peaks in the small-cap index ahead of Lehman going under in 2008 and the "flash crash" in 2010.

breakeven levels2

4. In concert with the SPX's failure at 1,333, the CBOE Market Volatility Index (VIX – 26.66) bottomed last week in the 20.49-21.36 area that is 50% above the March intraday low and closing low. In late April, this area acted as resistance and defined short-term buying opportunities for stocks. Since mid-May, however, pullbacks in the VIX to this area have signified selling opportunities. The next area to watch as potential resistance for the VIX is between 27.32 and 28.48, which is the double range of the VIX's March intraday and closing lows.

30-Minute Chart of VIX since April 23, 2012


The VIX and Effect on Breakeven Levels

It was considered that last Friday's 10.8% advance was relatively mild amid a near-2.5% drop in the SPX. Since 1990, there have been 98 instances when the VIX was below 30 ahead of a single-session SPX plunge of 2% or worse. The average VIX "pop" in this scenario was 14%, which suggests Friday's move was relatively mild. This might suggest a modest amount of complacency heading into the week ahead. Such a backdrop might leave the market vulnerable to additional selling, but hopefully not like that seen in January 2008!

In mid-January 2008, the VIX crawled higher by 2% (from 22.90 to 23.34) on a 2.5% SPX drop (similar to Friday's decline). During the following week, the SPX surrendered more than 5% before a short-term bottom was in place. This proved to be an extreme in complacency for 2008. Still, a VIX pop of 20% or more on Friday might have been a more comforting sign for the bulls, indicating that panic selling has finally arrived.

The sentiment backdrop continues to grow more pessimistic and remains consistent with negativity seen at major bottoms during corrective pullbacks the last few years. Hedge funds are no longer showing interest in stocks, the National Association of Active Investment Managers' NAAIM) survey reported the lowest allocation to equities since October 2011 (among active investment managers), and the 10-day, equity-only, buy (to open) put/call volume ratio is rising and approaching the Fall 2011 peak. The risk to bulls is that the sentiment backdrop worsen from here, but bears should also be on guard for a reversal in the sentiment backdrop, as major short-covering could follow.

Conclusion for Breakeven Levels in the Stock Market

As was mentioned last week, play the current risk in the market via put plays or short positions on large-cap financial names, such as JPMorgan Chase (JPM). Agricultural commodity stocks also look particularly vulnerable. If you are looking to enter long positions, a pullback to the SPX breakeven point or a VIX move into the 27-28 area could present decent entry points for potential short-term rewards, but keep your stops tight in the event the current pullback has more life in it.


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