This is an update of my March 17 post. It contains new ongoing research on MIDAS curves on independent fractal datasets (including in this post the Baltic Dry Index) and will therefore also be stored in the folder “Ongoing MIDAS Research”.

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A.Coles, March 23 2011

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Summary and Recap

One of several purposes of my last post of 17 March was to illustrate a new use of MIDAS curves on the VIX (ie, MIDAS volatility curves) and the MACD (ie, MIDAS momentum curves). I also raised the question whether there was another new use of the curves in this application, namely:

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Whether breaks of MIDAS support/resistance curves on independent datasets are actually advance warnings of breaks of price-based MIDAS support/resistance curves.

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I’ll further recap on this idea here before expanding it a little for purposes of ongoing monitoring. Later, I’ll also highlight very similar “advance warning” curve behaviour on the Baltic Dry Index to the behaviour on the VIX curves.

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First, let’s recap. Focusing on the VIX in my previous post, I noted in Chart 1 below that the VIX had last week crucially broken two MIDAS resistance curves that had been launched from the March 2009 subprime bottom while also breaking the more recent September 2010 curve.

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Chart 1: VIX with major break of complacency resistance into greater upside volatility (”fear”)

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The obvious question this raised was whether it should be taken as a warning that the corresponding MIDAS support curve (S1) from the same March 2009 subprime bottom would also be tested successfully on US indices (in particular, the S&P 500, DJIA, and Nasdaq 100). If the warning turned out to be correct, this would be another interesting new role for MIDAS curves when they could be plotted in these atypical contexts.

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Subprime S1 on the VIX, the S&P 500, and European indices

As for the S&P 500 itself, we can see from Chart 2 below that at the present time price is some way above the March 2009 subprime trendline as well as the S1 subprime support curve, while (as noted) the corresponding S1 curve on the VIX has been broken.

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Chart 2: S&P 500 with March 2009 subprime trendline and March 2009 subprime S1 MIDAS support curve

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However, support for the idea that the break of the subprime curves on the VIX may be forewarning of the break of subprime S1 on the US indices comes, interestingly enough, from several European indices, where the March 2009 trendline has been broken as well as the subprime S1 MIDAS support curve. For example, the March 2009 trendline has been broken on the DAX and I drew attention to it in my March 17 post (see here).

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However, if we look at Charts 3 and 4 below we can see that the MIDAS 2009 subprime curve corresponding to the VIX has either been well and truly broken or is currently being tested.

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Chart 3: Swiss Market Index continuous futures

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Chart 3 above is of the Swiss Market index futures, where we see the March 2009 subprime trendline broken as well as subprime S1 (last week). Chart 4 below is the futures on the Euro Stoxx 50. Most of our non-European readers will know that the Euro Stoxx 50 is Europe’s leading Blue-chip index for the eurozone, providing full representation of the supersector leaders. Consequently, it’s an important European bellwether complement to the S&P 500. As I write, the March 2009 subprime trendline and subprime S1 have become coextensive on the chart, and the index is testing both simultaneously, albeit S1 has already been broken some months before.

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Chart 4: Euro Stoxx 50 continuous futures

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Space prevents further charts here in relation to the March 2009 subprime trendline and the MIDAS subprime S1 curve, but here’s a summary below in Table 1 of what is currently taking place. As we can see, there’s been some substantial testing of the March 2009 subprime trendline and MIDAS subprime S1 curve.

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Table 1

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Comparison between Europe and US

What Table 1 demonstrates is the relative strength in the US markets as compared to Europe. Measured in relation to the March subprime 2009 trendline and the subprime MIDAS S1 curve, the only European markets to match the  strength of US markets are the DAX and the FTSE 100. Indeed, if we look at the DJ Global Stock Index/Excluding the USA, we see that this index too has tested the March 2009 subprime trendline along with most of Europe.

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*The DJ Greece index has not only broken the March 09 subprime trendline and the subprime S1 curve, it has also broken the actual March 09 subprime support. In doing so, the market has declined in a five wave Elliott impulse and is currently correcting this completed impulse.

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Chart 5: DJ Global Stock Index, Excluding the USA

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Conclusions

1. Volatility in the US options market as measured by the VIX vis-a-vis subprime VIX S1 has been much closer to sentiment in European and other world markets in comparison with the strength displayed in the S&P 500 and isolated European indexes such as the DAX and FTSE 100.

2. In the British financial press over the weekend, much emphasis was placed on the rebounding of global stocks towards the end of last week, with many commentators struggling to explain it. One intermarket explanation for improving risk-appetite was the first coordinated G7 intervention in the currency markets in 10 years to support the yen. Perhaps this did play some part, but it’s clear from the charts, both globally and European, that the brunt of the explanation stems technically from price testing the March 2009 subprime trendline and, in several indices, the MIDAS subprime 2009 S1 curve.

3. Will the breaking of the MIDAS subprime 2009 S1 curve on the VIX provide a genuine warning for what’s to come with regard to the same price-based curve on US indices such s the S&P 500? Time will tell, but as we’ve seen this curve has already been tested on several European indices.

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SHORT ADDENDUM: MIDAS curves on the Baltic Dry Index

If we look at Chart 6 below of the Baltic Dry Index (upper pane) and the S&P 500, we’ll see another application of MIDAS curves to economic time series, this time the Baltic Dry Index (BDI). However, we’ll also see similar MIDAS curve behaviour on the Baltic Dry Index to what we’ve seen on the VIX.

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Chart 6: the Baltic Dry Index (upper pane) and the S&P 500

I’ll write a separate post on the Baltic Dry Index later because its weakness makes interesting reading in relation to open interest on the Commitments of Traders (COT) Report. For now, however, we can see the same phenomenon in relation to the March 2009 subprime low on the Baltic Dry Index as we’ve seen on the VIX.

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The key on this chart is what’s being highlighted by the large blue and red curves on the right of the chart in relation to S1 and R1 on the S&P 500 (green) and the Baltic Dry Index. Notice that at the blue arrows the S&P 500 breaks above R1 but that the Baltic Dry Index fails to do so, with the result that R1 has been a strong resistance curve on the Baltic Dry Index since November 2009. Moreover, at the red arrows S1 acts as critical support for the S&P 500 in the rectangle, but the same S1 from the subprime low on the Baltic Dry Index is broken in March 2010. Since then, (second arrow) it too has become resistance, along with R1 further above it.

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Thus, the question again arises: Is the breaking of S1 from the March 2009 subprime low on the Baltic Dry Index (= the breaking of the same S1 March 2009 subprime curve on the VIX) warning of a similar breakdown of the price-based S1 on the S&P 500? This is a compelling question, because we now have two independent time series (volatility and economic) breaking the subprime S1 curve alongside several European indices.

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This is ongoing work and I’ll update the corresponding ongoing thread in these posts periodically.

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