We find it amazing how many times the markets, the media, and many, many analysts are always waiting for that next crucial data point. And when that “important” data point or speech finally arrives, it turns out so many times to be a non-event. When the news is bad, but the market rallies, the spinsters find some reason for the surprising rally. When the news is good and the market falls, well you know. As we have said many times, price leads the news, and we continue to believe that the stock market is poised for a large move higher during the next couple of months. Over the past couple of weeks, the major stock indices as well as many individual stocks have paused or pulled back very quietly, and it appears to us that they are setting up for the next leg higher. Quiet, listless markets are not signaling a market top, but rather a refueling before the next fireworks begin.
So far, the S&P 500 has seen a very minor pullback to its 13-day exponential moving average. During fluid moves higher, this is many times all you get as far as a decline. In addition, the “500” has only retraced a minor 23.6% of the rally since July 24, which is the minimum pullback in an uptrend. On the intraday (30- and 60-minute) charts, it appears that the index completed a small three-wave decline, and may be set to lift off. On the daily chart, we have only seen one wave down, which, in our view, is reminiscent of many pullbacks during the third wave of an advance. The key upside chart resistance for the near term is the 1,420 region, and we believe a strong break above this area opens up the possibility of a rally to 1,500+ over the next two months, and toward all-time high territory in the first quarter of 2013.
The VIX, a measure of market expectations of near-term volatility based on option prices of the S&P 500, is closing in on a sell signal, which equates to a buy signal on the stock market. A sell signal on the VIX consists of three steps, with the first and second being a close outside the standard Bollinger Bands, and then a close back inside the bands. The third step is a lower close on the VIX than the close of the day that the VIX first finished back inside the bands. If things stay as they are, the first two steps will have been tripped.
We get quite amused when we read and hear comments on the VIX, as many times they are just flat-out wrong. There are many saying that the recent VIX readings of near 15% (currently 17.4%) are signaling complacency. Well, what does this mean? The options market is saying that there is a 2/3 chance that the S&P 500 will either rise or fall by 15% over the next year. This equates to a rise to 1,621 or a decline to about 1,200. That range of price expectations doesn’t really seem complacent to us. Furthermore, we think the analysts who are calling the recent readings complacent are not really looking at enough history, but selectively recalling the three spikes in the VIX that have occurred over the past four years. So yes, the current VIX is of course much lower than the levels during the 2008/2009 bear market, and below the levels during the pullback in 2010 and the major correction in 2011. But it is still a lot higher then it was during parts of the 1990s bull market as well as the 2003 to 2007 bull market. During those bull runs, the VIX dropped to 10 and stayed low for considerable periods of time. Some of the best gains during recent bull markets have come with a VIX reading below 15. So, if we continue to trade in at least a cyclical bull market and perhaps transition to a secular bull market as we have projected, we actually think the VIX could be way overvalued, and showing too much fear.
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