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To say that complacency
has reigned in the last few months is an understatement. Volatility as measured by the CBOE
Volatility Index (VIX) has fallen 60% since October and 20% since the start
of 2012.
To put into context just
how much volatility has fallen since the latest rally kicked off in October,
the 10-year chart of the S&P 100 Volatility Index (VXO) is shown
below. The VXO is an excellent
frame of reference for the absence of widespread fear in this market in
recent months. As you can see,
volatility is approaching historically low levels not seen since before the
credit crisis began.
Options traders often use
readings in the VIX and VXO to gauge whether investors have become overly
complacent. It has been noted
that when volatility subsides to historically low levels like we’re now
seeing, it tends to generate its own reversal (based on the contrarian
principal that the crowd can’t be on the right side of the
market’s trend for long).
But the old saw that
retail investors “can’t be right for too long” can
sometimes be misleading. Check
out the years 2004, 2005 and 2006 in the above chart and you’ll see
what I mean. These were low
volatility years by historical standards and the market remained in strong
hands for the most part during this 3-year period. The reason for this sustained period
of low volatility can be attributed to the position of the longer-term yearly
cycles during 2004-2006. The 6-year,
10-year 12-year cycles were either up or peaking during much of this time
period. This doesn’t even
take into account the influence of monetary policy and bank credit factors
which were then in effect.
On a shorter-term basis,
volatility is largely influenced by the weekly Kress cycles, or more
specifically, by the interaction between the peaking and bottoming
cycles. Cyclical cross currents
create market volatility and this volatility is reflected by an increase in
the VIX. VIX has been abnormally
low in recent weeks, which has coincided with an increasing level of investor
complacency. Again, we
aren’t justified in assuming that because complacency is high and
volatility is low that the intermediate-term uptrend for stocks is
doomed. Rather, we must look for
answers from the weekly cycles.
The nearest weekly Kress
cycle of intermediate-term consequence is scheduled to peak next Friday, Feb.
17 (plus or minus). A second
interim weekly cycle will peak around March 9. There is a greater than average chance
that one of these two cycles could put a significant peak on the market,
though we won’t know for sure which of the two dates is most likely to
be the interim high until closer to the cycle peaks.
The question we need to
examine is whether the upcoming cycle peak next week will put the interim
peak on the market. While we must
be prepared for this possibility, I don’t believe the next few days
will witness anything beyond a short-term market peak, which in turn would
offer the market a much-needed breather after its run-up of the last several
weeks. There is still a strong
current of internal momentum behind this market which argues against a major
interim top happening right now.
The following chart shows
the extent of this strong intermediate-term momentum. The blue line is the sub-dominant
interim momentum for the NYSE stock market while the red line is the dominant
interim momentum. Both are still
rising at a solid rate of change and should act as a support against any
attempt by the bears to raid this market in the coming days while the first
of the two weekly cycles peak.
Although the broad market
still enjoys a strong measure of underlying support from this internal
momentum, volatility looks to be on the rise in the coming weeks. The CBOE Volatility Index (VIX) broke
out decisively above its 15-day moving average for the first time since
November as you can see here.
Most of the internal
momentum indicators which comprise the HILMO index are still in an upward trend. One indicator that is diverging from
the rest is the dominant longer-term momentum indicator (below), which is the
longest of the internal momentum indicators in the HILMO index. The indicator has made a series of
lower highs as you can see here and has just re-entered negative territory as
of Friday, Feb. 10.
The interplay between the
declining longer-term momentum and the rising intermediate-term momentum
discussed previously is likely to create some volatility in the weeks
ahead. Volatility was extremely
low in recent weeks, mainly because NYSE internal momentum was synchronized
to the upside. Now that this is
no longer the case, the friction created by these internal cross-currents
typically brings about increased volatility, which is normal around a weekly
cycle peak. Thus we can probably
expect to see more an increasing amount of volatility from here, especially after
the March cycle peak.
As an accompaniment to
the loss of cyclical support within the next few weeks, we should also expect
to see a return of Wall Street’s fixation on the eurozone debt drama.
Investors have gotten a reprieve from the constant bombardment of negative
headline over the Greek and Italian debt crises. That’s typical of a market
environment were the weekly cycles are synchronized to the upside – in
such periods as we’ve experienced the last few weeks, good news tends
to dominate the headlines and bad news is put on the backburner.
With the return of
cycle-induced volatility we can expect to see the financial press fixating on
bad news once again. And the
media won’t have to search far in order to find something negative to
fixate on: the “Greece trap” is the most obvious choice.
Gold ETF
After confirming an
immediate-term buy signal just three days into the New Year, the SPDR Gold
Trust ETF (GLD) has closed below its dominant immediate-term 15-day moving
average for the first time this year.
GLD advanced 8% from its initial buy signal in early January to its
recent peak on Feb. 2. On
balance, an 8% rally from an immediate-term buy signal is typical, especially
when internal momentum is rising (as it was until late January).
The latest close under
the 15-day MA technically qualifies as an immediate-term sell signal for GLD,
though there’s still a chance this signal will soon be reversed. How gold reacts to the upcoming Greek
bailout vote will set the tone for the weeks ahead.
Clif Droke
Editor, The Daily Durban Deep/XAU Report
Clifdroke.com
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