Many people have the mistaken idea that high volatility (VIX) means falling markets. They’ve been trained by financial news outlets to associate volatility with fear. This notion is only half right. Volatility is also connected to greed. In reality, volatility is a reflection of the size of a price movement regardless of the direction. Take a look at the chart below and you’ll see that during the late 1990s price was rising, but in wide daily ranges. This caused VIX to rise substantially while the market was going up. VIX went up from about 10 to 27 (170%) while the S&P 500 index (SPX) almost doubled from late 1995 to just before the Russian financial crisis of 1998. So without much “fear” in the market VIX nearly tripled. After the Russian financial crisis VIX stayed elevated in a range between roughly 19 and 30 as SPX climbed 38%. Large range days while the market was rising created an elevated VIX. SIDE NOTE: I’m using VIX to show the price move
Although the intermediate term indicators we follow are mostly positive, I’m seeing some short term caution signs from the Trade Followers Twitter and StockTwits indicators. An example is the chart for volatility below. You can see the full article here.
As I suspected last weekend, the market was poised to move to new highs. The S&P 500 Index (SPX) is there this morning. One of the charts we’ve been following is VIX vs. VXV. It has been below .9 most of the week and looks like it’ll give an official all clear signal tomorrow. I’ll do a full update of our core indicators tomorrow and highlight other general market indicators over the weekend.
Last week I mentioned that the nature of the bounce would tell us if we’re headed to new highs or seeing a failed rally. As of this week we’re on track to see new highs…if Russia and Ukraine will just cooperate. The underlying indicators I watch are improving enough to support a move to new highs, but the fear of a larger war in Ukraine is putting a drag on the bounce. As a result, risk is the most important indicator to watch at the moment. Even with world tension our market risk indicator backed away from a warning last week. Now only one of its four components is warning (and it has turned back up). Our core measures of risk continue to signal all clear. Fear of risk is moving the right direction and should support the market in the absence of bad news. The ratio between VIX and VXV improved last week, but still couldn’t get back below .9 to signal the rally should continue. It was below
I’m starting to see some positive signs that the dip is behind us. First is Elder Impulse for the S&P 500 Index (SPX). It has a tiny blue bar for the week. If it can hold or move to green by Friday it will be a very good sign. Next is the ratio between VIX and VXV. If fell below .9 today. It needs to hold below that level for the rest of the week to signal the worst is behind us. The next two hurdles to cross are from price on SPX. The 50 day exponential moving average is where the market closed today and the 50 day simple moving average is near 1955. In addition, the most tweeted levels for the market are near the 1955 area. If those two levels are surpassed then the odds will favor an advance to the all time highs.
It’s looking like the market is ready for a bounce. The nature of any bounce will tell us whether we should expect new highs or if the rally will fail. Here are some of the critical charts I’ll be watching over the next week or two. A chart I show often when the market is starting a move lower is the ratio between near term volatility (VIX) and mid term volatility (VXV). Spikes in this ratio show immediate fear is greater than longer term fear. They are usually associated with an event or a sudden recognition of danger by many market participants. When the market bounces out of a short term low this ratio can help us determine if near term fear is subsiding or lingering. Over the next few weeks we want to see it fall below .9 to give the all clear signal. If it can’t move below that level the odds favor more downside ahead. This indicator couldn’t clear the warning two weeks ago and signaled that
The trend that started two or three weeks ago where our core indicators moved up and ancillary indicators fell continues again this week. Below are updates to some of the things I’m watching without much commentary. You can view this post for an explanation. I use the ratio between VIX and VXV to signal “all clear” when it falls back below .9 after a choppy of falling market. It couldn’t quite get there this week. Large caps are still outperforming small caps…rotation to safety starting? Junk bonds (JNK) are still under performing high quality bonds (LQD)…risk off. The individual stocks I’ve been watching for clues to a direction are starting to diverge. Market participants are becoming more selective in the momentum names which caused a decline early in the year. Here are some examples. Twitter (TWTR) is still in a holding pattern and hasn’t decided which way it wants to go. Baidu (BIDU) is breaking higher. 3D Systems (DDD) looks like it’s breaking down.
Over the past week we got more of the same from the indicators I follow. The market chopped around and our indicators had a slight decline. Market participant appear to be chasing price and being whipsawed by choppiness. This action is showing up in market internals. An example is the ratio between near term volatility (VIX) and mid term volatility (VXV). On a daily chart it moved above 1.0 signalling caution right at the low of the last dip. Then when it moved back below .9 (usually signalling “all clear”) the market lost momentum and looks to be rolling over again. The weekly chart of VIX vs. VXV shows two caution signals (above 1.0) since the first of the year that occurred on small dips in price. In addition, both VIX and VXV are making lows above all of the 2013 lows. This indicates not only increased caution by market participants, but a bit of skittishness. It is reacting much the same as measures of breadth that I’ve mentioned since
By almost all the measures I track it’s make or break time for the market. I’m seeing a pattern in both core and ancillary indicators that has often marked lows in the market over the past few years. Each time our indicators were close to signalling an extreme warning the market promptly turned back up and resumed the rally out of the 2009 lows. Over the longer term when our indicators have reached these levels the market rallied 35% of the time and had an extended decline or choppy period 65% of the time. As you know, I can’t see the future so all we do is go with the odds. As a result, our core portfolios raised cash and/or added a hedge yesterday. Here are some highlights of things I’m seeing that makes me cautious. The ratio between near term volatility (VIX) and 3-Month volatility (VXV) is currently rising as a result of both VIX and VXV moving up. This is a condition that has only occurred a few
Over the past week the rotation out of the most loved and momentum stocks into value stocks continued. The rotation is causing internal damage to our core indicators, but our measures of risk aren’t showing any fear. This paints a picture of market participants simply taking profit on the stocks in their portfolios that had the largest gains over the past year. Any fear appears to be limited to the high flying stocks, not the market as a whole…yet. I’m seeing a lot of warning signs which suggest caution, but not aggressive action. The percent of stocks in the S&P 500 Index above their 200 day moving average has recovered from its early February dip and is holding steady near the 80% level. However, a look at individual charts shows many stocks painting bearish flag patterns just above their 200 day moving average. General Electric (GE) is a good example. The number of new highs on NYSE diverging from the market shows that a significant number of individual stocks (like