VIX at 5 ½ Year Low – What Does it Mean for Stocks?

The VIX staged a historic performance over the last 16 trading days. It took 8 trading days to soar 47% and another 8 trading days to drop 43% to a 72-month low. What’s next for the VIX and what does it mean for the S&P 500?

From December 28 – January 9 the Volatility Index (VIX) dropped 43%. Such deterioration of implied volatility is unprecedented in the 20+ year history of the “Fear Index.”

On Wednesday, the VIX fell as low as 13.22, the lowest level since June 20, 2007. Extremes like this often plant the seeds for massive trade opportunities, they are music to our ears.

Is there any significance to the recent VIX behavior and its 72-month low? What does a low VIX mean for stocks?

VIX/S&P 500 in 2010

A low VIX in 2010 and 2011 always spelled trouble for stocks. On April 12, 2010 the VIX fell as low as 15.23. The S&P 500 topped on April 26 and dropped 17% thereafter.

VIX/S&P 500 in 2011

The same top and drop scenario happened in 2011. On April 20, 2011 the VIX moved as low as 14.30. The S&P 500 topped on May 2 and fell 21% thereafter.

VIX S&P 500 in 2012

In 2012 the VIX stair-stepped as low as 13.30 on August 17. The S&P didn’t top until September 14. Although the S&P corrected as much as 8.8%, the VIX barely moved higher. In fact it still traded at 13.67 on October 5.

What’s the takeaway? As the chart below illustrates, the VIX/S&P 500 correlation was a helpful timing tool in 2010 and 2011, but not in 2012. In fact, the VIX 2012 performance had little correlation to its historic seasonal pattern.

Better Use of the VIX

I’ve found it helpful to extract buy/sell signals via the VIX’s interaction with the Bollinger Band. On December 31 the VIX closed below the upper Bollinger Band.

The January 1, Profit Radar Report stated that: “This is a VIX sell signal and a buy signal for stocks.”

VIX/S&P 500 Outlook

The VIX closed near its high of the day yesterday, forming a possible reversal candle against a potentially bullish RSI divergence. The immediate down side for the VIX seems quite limited. Going long the VIX at current prices provides a much better risk/reward ratio than going short.

Trading the VIX is difficult as options suffer from time decay and futures from contango. VIX exchange traded products – like the iPath S&P 500 VIX ETN (VXX) and VelocityShares Daily Inverse VIX ETN (XIV) – provide exposure to the VIX, but suffer from the same problems as they use options and futures to replicate the VIX performance.

With or without setback, I expect the S&P 500 to labor a bit higher towards key resistance before a possible major reversal.

Early Indicators Show 87.5% Odds That 2013 Will End Higher

Investing is a game of probabilities and the beginning of each new year hosts a number of pretty good barometers with decent track records. Two combined indicators put the odds of a positive 2013 at 87.5%.

The S&P 500 is about to reach a key inflection point. How it reacts there will probably set the tone for the first 6 months of 2013. Once the S&P reaches this “fork in the road,” I expect it to turn down.

Regardless of ones bias, you can’t be blind to other indicators and two of them are quite bullish.

Santa Claus Rally (SCR)

The SCR covers the last 5 trading days of the old year and 2 first trading days of the new year. The 2012/13 SCR delivered a 2.0% gain for the S&P 500, a 1.5% gain for the Dow Jones and 2.6% pop for the Nasdaq.

Since 1950, a positive SCR for the S&P 500 has resulted in full year gains 62.8% of the time.

First 5 January Days (F5D)

A lousy performance during the first 5 trading days of the year is often viewed as an early warning signal for the entire year. It doesn’t like look the F5D will be waving any red flags this year. Unless the S&P closes below 1,426.19 today, the F5D will be positive.

Used as a barometer, the first 5 days have correctly predicted the full year outcome (up or down) 62.8%.

Santa Claus Rally + First 5 Days

What happens when we combine the SCR and F5D barometers? Since 1950 the SCR and F5D have been up 21 of 24 years for a success ratio of 87.5%.

Based on this, the odds for 2013 ending up in the green is 87.5%.

Once again, I don’t buy those odds, at least not yet. I am waiting for the results of another indicator, one with a 92.3% accuracy ratio. I’m also waiting how the S&P 500 reacts at its fork in the road point.

The results of the 92.3% accurate indicator and the level for the S&P 500 inflection point will revealed by the Profit Radar Report.

Red Flag or Bullish Signal – Russell 2000 At All-time High

The Russell 2000 is like the little engine that could. Despite all kinds of fundamental and economic headwinds, the index most susceptible to liquidity constrains (and obviously QE) is trading at all-time highs. Is this a red flag?

Have you heard about any of the following companies? Ocwen Financial, Genesee & Wyoming, Two Harbors Investment, Pharmacyclics and Commvault Systems.

They are the top 5 holdings of the Russell 2000 Index. In case you haven’t noticed, the Russell 2000 – a small cap stock index – has quietly soared to new all-time highs.

What? Yes, the Russell is trading higher now than at the 2000 or 2007 highs or any other time in history. That alone is amazing, but on a relative basis it’s nearly mind-boggling.

In 2000 or 2007 there was no threat of a fiscal cliff, financial crisis, or looming default of multiple European countries.

On a relative or global risk adjusted basis, the Russell 2000 (corresponding ETF: iShares Russell 2000 ETFIWM) and pretty much every other broad market index is no doubt over valued.

Nevertheless, the December 26 article “Will Small Caps Lead the Market to All-time Highs?” published here on iSPYETF stated that: “Historical seasonal patterns suggest that more strength lies ahead for small caps. Technicals support this view. This may drive small caps to new all-time highs.”

The Russell 2000’s strong performance is one of the reasons the Profit Radar Report stubbornly stuck to its bullish December/January forecast.

Is the Russell’s new all-time high a red flag or a bullish breakout?

Starting in mid-to late January, the Russell 2000’s seasonal edge relative to the S&P 500 and Dow Jones will wane.

Another indicator worth watching is RSI. Wednesday’s new price high occurred against a lower RSI. The margin between the prior RSI high and current reading is small though, and any new price high could push RSI to a new high as well.

Bigger market tops are generally accompanied by bearish divergences (new price high void of new RSI high), so a new RSI high would increase the odds of a higher price later in the year, while a bearish divergence would be a red flag.

There’s a Fibonacci projection resistance around 874, which is keeping a lid on the currend advance. As of this moment the Russell’s new all-time is neither bullish nor bearish, but the next Russell 2k moves may hold valuable clues for the rest of the market.

Will The S&P 500 Reward Politicians Shenanigans With New Recovery Highs?

It seems like the stock market is rewarding short-sighted politics and alibi deficit deals, but that’s not the case. The stock market seems to have a specific agenda revealed by a little-known but effective indicator.

I don’t like to dignify bad behavior. That’s probably why I’ve only written about the fiscal spectacle once before (December 7: Will the Fiscal Cliff Really Send Stocks Spiraling?).

Stocks rallied strongly on news that Congress approved a quick fix that buys a little more time. Will the S&P 500 and SPY ETF even go as far as reward politicians’ shenanigans with new recovery highs?

Confession Time

I have to admit that we didn’t get to profit (at least not much) from this week’s explosion to the up side. That’s not because it wasn’t expected.

The December 23 Profit Radar Report wrote that: “The decline from September 14 – November 16 was a correction on the S&P’s journey to new recovery highs. This scenario is supported by the lack of bearish price/RSI divergences at the September 14 high, continuous QE liquidity and bullish seasonality.”

The same update also warned that: “the S&P is littered with resistance levels from 1,417 – 1,440. This suggests that any immediate up side may be choppy.”

In fact, the up side was so choppy that it diluted many support/resistance levels and made it tricky to find a low-risk buying level. The chart below (it looks busy, that’s why there was no low-risk entry) highlights the support/resistance levels rendered nearly useless by 5 weeks of zig zagging back and forth.

This is frustrating, but crying over spilled milk is of no benefit. There will always be another trade set up, in fact a huge setup is in the making right now.

Wednesday’s move above 1,448 unlocked a number of temporarily bullish options. The up side from here is probably going to be choppy and limited, but should lead to the best low-risk sell signal in well over a year.

I am using a little-known but effective strategy to project the target (and reversal zone) for the current rally. Effective because the strategy is a mirror image of the strategy I used to pinpoint the April 2011 high (at S&P 1,365), which led to a 300-point free fall.

This strategy suggests a new recovery high followed by a major top. I don’t know if the reversal will be as significant or more significant than the one in April 2011, but investing is a game of probabilities. The odds for a low-risk entry just don’t get much better than this.

The latest Profit Radar Report reveals the little known strategy used to project the target for this rally along with the actual target level for a potentially epic reversal.

How Much is the Dow Worth in Real Currency

The Federal Reserve is devaluing the U.S. dollar. Contrary to popular belief that hasn’t resulted in outright or obvious inflation, but as the Gold Dow shows, it is eating away at the Dow’s value.

How do you define value and is value important today or is value just relative?

After all, as long as you buy low and sell high, the value of the underlying stock, index or ETF doesn’t matter, or does it?

If you buy the Dow (or Dow Diamonds – DIA) at 13,000 and sell at 14,000 you pocket a nice profit, but was it a good value buy?

Obviously profits are always right, but value often determines profits. At least that used to be the case before the Fed’s flooded the market with liquidity.

Old souls that remember the name Charles Dow and his saying “to know values is to know the market” may find the chart below of interest.

It measures the Dow in the only real currency – gold – that’s why I call it the Gold Dow.

The Dow in U.S. dollars is shown in black, the Gold Dow is shown in gold. At the 1999 Gold Dow peak, the Dow Jones was worth 42 ounces of gold. Today it’s barely worth 8 ounces.

The 81% drop in the Gold Dow is largely due to gold prices, which soared from 260 in 1999 to 1,600 and above.

Thus far the Dollar Dow has been able to resist the path of the Gold Dow. In fact, there’s been a divergence for most of the past decade, so this is not a short-term timing tool. Nevertheless, other valuation indicators suggest that the Dollar Dow will eventually follow the footsteps of its golden cousin.