VIX Seasonality Suggests Higher Readings

The VIX is back to 2007 levels and actively defying the contrarian implications of extra low VIX readings. Will the VIX drop much further? A look at VIX seasonality provides some clues.

When complacency reigns, investors get wet or at least so goes the saying. The CBOE Volatility Index (VIX) has been trading below 15 for all of 2013, but the only ones getting ‘wet’ are VIX bulls and stock bears.

Still, the VIX is at a 73-month low and eventually there’s some money to be made buying VIX calls or long VIX ETFs. When will that be? VIX seasonality provides some clues.

VIX Seasonality

The first chart provides a visual of VIX seasonality based on data from 1990 – 2012. A devisor has been used to equally weigh each years’ performance.

In an average year, the VIX has seasonal lows in early and late February before spiking to an early March high. This would provide a short window for a seasonal move higher.

The average February to March VIX spike is less than 10%. Obviously, there’s more potential upside in 2013 as the debt and deficit ceiling quandary has the potential to springboard the VIX from its 73-month low.

However, the VIX seasonality chart suggests to eat your ice cream before it melts. In other words, locking in any gains (or carefully managing any gains) before the early-March seasonal high is prudent.

S&P 500 Seasonality

Most of the time there’s an inverse correlation between the VIX and the S&P 500. When the VIX goes down, stocks go up and vice versa.

Does S&P 500 seasonality confirm VIX seasonality? It would in a perfect world, but investing is about odds, not perfection.

The second chart plots overall S&P seasonality (1950 – 2012) and post election year seasonality against VIX seasonality. VIX seasonality (blue line) is inverted for easier comparison of trends.

The dashed red lines mark three trends that line up. One is a mild early-to mid February sell signal (sell signal for stocks, not VIX) followed by a weak late June buy signal and a strong October buy signal.

S&P seasonality also suggests that any February correction may be short-lived.

Seasonality charts capture the general trends of more than six decades and averaging of trends eliminates a lot of ‘seasonal noise’ along with potential setups.

Nevertheless, when seasonality agrees with other indicators (like sentiment, technicals, fundamentals) we get a stronger signal. This could be the case right now.

Long VIX ETPs include the iPath S&P 500 Short-Term Futures ETN (VXX) and VelocityShares Daily 2x VIX Short Term ETN (TVIX).

Short S&P 500 ETFs include the Short S&P 500 ProShares (SH) and UltraShort S&P 500 ProShares (SDS).

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Stock Buying Climaxes Are On The Rise

The SPDR S&P 500 (SPY ETF) is grinding from one marginal new high to the next, while ‘strong hand’ investors are quietly and persistently unloading stocks. 

To understand the merit of buying climaxes we need to know what they are. Buying climaxes occur when a stock climbs to a 12-month high, but closes the week with a loss.

Buying climaxes are a sign of distribution and indicate that stocks are moving from strong hands to weak ones. Strong hands are generally the kind of investors that hold on to stocks through thick and thin.

Weak hands tend to be fickle latecomers that join an established trend that may be running out of steam. Weak hands are trigger happy and quick to sell.

Investors Intelligence publishes buying and selling climaxes every week. We just saw the third consecutive reading above 100. This is not extreme, but reason to be cautious.

The last time we saw three consecutive +100 readings was in March/April 2012. The S&P 500 fell 150 points thereafter.

Technical Analysis – Will Google Continue To Climb?

Google is trading at an all-time high but momentum is vanishing and RSI is showing two bearish divergences. This alone isn’t a sell signal, but a break below support should be.

A stock that’s trading at all-time highs has little overhead resistance and an unobstructed view to even higher prices targets.

After a truly nasty 18% selloff in October/November 2012, Google soared to new all-time highs. What’s next from here?

Like any other momentum move, Google’s momentum run will eventually take a breather. A number of indicators suggest that any upcoming correction may be more on the shallow side.

But there’s no law that says you need to suffer through corrections hoping that it remains fleeting and short-lived.

The chart below shows a dashed green trend line. A break below would be a first warning sign. A close below the horizontal support line at 760 would open the door to further losses.

Our last Google update (Will Google’s Fumble Take Down the Entire Technology Sector) was posted on October 19 (dashed vertical gray line) and said:

GOOG trading volume was through the roof as prices tumbled below the 20 and 50-day SMA and a couple of trend lines. Prices generally stabilize somewhat after large sell offs like this before falling a bit further. A new low parallel to a bullish price/RSI divergence would be a near-term positive for Google.”

The down side risk for Google and the entire tech sector was limited as the article pointed out that: “Next support for GOOG is around 660 and 630. The Nasdaq Indexes and the Technology Select Sector SPDR (XLK) has been much weaker than the Dow Jones and S&P 500 as of late. There were no bearish divergences at the recent S&P and Dow highs. This lack of indicators pinpointing a major top limits the down side of the tech sector.”

The lower green lines represent support at 660 and 630. Following a period of stabilization in late October, Google fell as low as 636 against a bullish RSI divergence and has been rallying ever since.

There’s no solid evidence that Google’s run is over, but RSI at the bottom of the chart is showing signs of fatigue and bearish divergences on multiple timeframes.

Bearish divergences can go on for a while and in itself are no reason to sell, but the bearish divergences combined with a close below 760 would point towards more weakness and could be used as a signal to go short for aggressive investors.

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Weekly ETF SPY: Junk Bond ETFs Breakdown – Canary in the Mine?

Who is the best canary in the mine? It is said that bond traders are smarter than stock traders. Considering that junk bonds are showing cracks, it might be interesting what the ‘canary’ has to ‘chirp.’

‘Are Junk Bonds Ready to Fall?” – USA Today
‘Junk Bonds Flash Warning Signal’ – MarketWatch
‘Junk Bond Decline: Should You be Afraid?’ – Barron’s
‘Junk Bond Risk Climbs in Europe as January Issues Reach Records’ – Bloomberg
‘High-Yield Selloff Just Beginning?”

When times are good, junk bonds (or junk bond ETFs) are called high yield bonds. When times are bad, they’re called by their real name, junk bonds.

Based on the above headlines, high yield bonds have fallen out of favor. At least that’s the media consensus. What does technical analysis show?

The chart for the SPDR Barclays High Yield Bond ETF (JNK) doesn’t look impressive. JNK just closed below trend line support. The recent all-time high was also accompanied by a bearish RSI divergence.

Although the technical picture looks similar, the JNK breakdown is not confirmed by its ‘junkie cousin’ – the iShares iBOXX High Yield Bond ETF (HYG). HYG remains above trend line support.

Does HYG matter more than JNK or vice versa? Probably not. JNK trades more actively (4.3 M shares compared to HYG’s 3.5 M), but is smaller ($12.8 B vs HYG’s $16 B).

Anyone short JNK may use the red trend line as stop-loss guide. The prudent approach is to wait for HYG to confirm JNK’s breakdown.

JNK and HYG have both decoupled from the stock market. Bond traders are often considered smarter than stock traders and viewed as canaries in the mine. If that is true, stocks and bonds may be about to hit a rough patch.

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Real Nasdaq Lagging, But Ex-Apple Nasdaq Just Hit 12-year High

Stock market domination by one stock is a double-edged sword and Apple’s two-fold for better and for worse mastery over stocks has introduced the need for a more objective technology index – The ex-Apple Nasdaq.

Much has been written about the bearish divergence between the Dow Jones and S&P 500 compared to the Nasdaq and Nasdaq-100.

In fact, the Nasdaq-100 is trading 4.5% below its 2012 high, while the S&P 500 is trading more than 2% above its 2012 high water mark.

This could be (and has been) interpreted as a bearish sign, but that’s not necessarily the case.

For better and for worse the Nasdaq-100 has been hijacked by one stock – Apple. A few months ago Apple accounted for more than 20% of the index. As Apple went, so did the Nasdaq-100 (more about the correlation between Apple and Nasdaq here).

Just in September, Apple drove the Nasdaq-100 to the highest point since the 2000 tech bubble. Since then Apple lost as much as 35%. Apple’s decline has been a significant drag on the Nasdaq (corresponding ETF: PowerShares QQQ) and technology sector (corresponding ETF: Technology Select Sector SPDR – XLK).

Apple’s performance is holding the Nasdaq back from reaching new recovery highs, but the Nasdaq-100 without Apple’s drag (aka ex-Apple Nasdaq-100) would trade at new 12-year highs.

I haven’t figured out a way to reconstruct an exact ex-Apple Nasdaq-100 index, but a comparison between the PowerShares QQQ ETF and First Trust Nasdaq-100 Equal Weight ETF (QQEW) illustrates the point.

QQEW assigns an equal weight to all Nasdaq-100 components. The equal weight approach doesn’t eliminate Apple, but it comes close to an ex-Apple Nasdaq index.

The first chart plots the price of QQQ against QQEW since the March 2009 low.

The second chart shows the percentage gain of QQQ and QQEW since March 9, 2009. Although QQQ and QQEW took different routes, both ETFs gained exactly 167% from March 9, 2009 – February 1, 2013.

The steepest portion of AAPL’s ascent started on November 25, 2011. Within the next 10 months AAPL soared from 370 to 705. The powerful rally was followed by a gnarly 35% drop.

The third chart captures the period from November 25, 2011 – February 2013. This period includes Apple’s steep ascent and subsequent descent. The equal weighted Nasdaq-100 ETF (QQEW) clocked in at the highest level since December 2000 just a couple of days ago.

Never before has any one single stock exerted so much power on the stock market as a whole. This illustrates that extraordinary times call for ‘extraordinary’ and out of the box analysis.

Stripped of Apple’s performance, the Nasdaq-100 is trading at new recovery highs, thus erasing the bearish divergence between the senior U.S. indexes. This doesn’t mean stocks can’t decline, but it won’t be because of a true bearish divergence.

AMaZiNg – 3,893 Tech Sector P/E Ratio Is Back

Quadruple digit P/E ratios – like 3,893 – were thought to be in the past. Courtesy of America’s premier online retailer we just got a flash from the past. Does that mean it’s time to party like it’s 1999?

Triple and quadruple digit P/E ratios of the late 1990s are fond memories for some and nightmares for others.

Regardless of your memories, the fifth largest component of the Nasdaq-100 just hit a P/E ratio of 3,893. Who is this ‘bubbleishous’ tech stock? Amazon.

Talking about nightmares, Amazon has become a nightmare to brick-and-mortar retailers. Amazon is spending tons of cash to make sure Amazon’s e-commerce site haunts brick-and-mortars day and night.

As the chart below shows, Amazon’s revenue (green columns) has grown steadily, but net income has taken a hit as profits are reinvested into new warehouses, called ‘shipment hubs.’

In 2012, Amazon added 20 shipment hubs, which decreased shipment costs from 4.5% of sales to 5.4% of sales (about $430 million).

Amazon’s gross margins widened from 20.7% to 24.1% and investors applauded the aggressive expansion, sending AMZN to an all-time high.

AMZN accounts for only 1.02% of the SDPR S&P Retail ETF (XRT), nevertheless, XRT is also trading at an all-time high.

Does this validate a P/E ratio of 3,500+ though? It’s a classic scenario of ‘mind over matter.’ As long as investors don’t mind, it doesn’t matter.

S&P 500: Rocky Season Ahead

The S&P 500 just nailed the best January gain since 1997 and 2013 forecasts are quite positive. Although the ‘Great QE Bull Market’ may not yet be over, seasonality suggests a rocky February.

The S&P rallied a decadent 5% in January and 2013 has been smooth sailing for stocks thus far.

The Federal Reserve probably deserves a fair share of credit for keeping the stock market humming.

Considering QE’s effect on the liquidity pool, it might be beneficial to look at stocks’ seasonal performance since the onset of ‘modern QE.’

The chart below compares the 2010, 2011, 2012 annual S&P 500 performances (2013 in red).

2011 and 2012 started out quite similar to 2013. In 2011, the S&P rallied until February 18 before correcting and turning choppy. In 2012 the S&P rallied until March 27, but a couple of 3-4% corrections introduced some choppiness already in late January. 2010 saw a mean 7% selloff materialize already on January 19.

A look at longer-term seasonality (going back to 1950) shows weak February performance in overall S&P 500 seasonality, post-election year seasonality, and post-election year seasonality with a democratic president.

CBOE Volatility Index or VIX seasonality shows a minor VIX low early in February (detailed seasonality charts for the S&P 500 and VIX are available to Profit Radar Report subscribers).

Sentiment (Article: How Worrisome is Bullish Sentiment?) suggests that a cooling period is approaching.

In short, February is quite likely to bring lower prices for U.S equities. Depending on your investment strategy and future outlook, this is either an opportunity to unload stocks before prices drop or pick up stocks at a lower price tag later on.