So says the Economic Fanatic (www.economicfanatic.com) in edited excerpts from an article posted on Seeking Alpha.
Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!) has edited the article below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.
The article goes on to say, in part:
Factor #1: The VIX
The first factor pointing to a possible reversal in the S&P 500 index is the fact that the VIX has touched a five-year low of 13.45 at the end of last Friday’s trade.
Click to enlarge
VIX, also known as the fear index, is a measure of the market participant’s expectation of volatility over the next 30 days. A low VIX would, therefore, mean low volatility expectation and should not really concern investors.
Factor #2: The VIX in Relation to the S&P 500 Index
My caution, however, comes from the observation and behavior of the VIX in relation with the S&P 500 index in the last 10 years [see below].
As the chart shows, there has always been a reversal in the VIX index from lower levels and it has been associated with decline in equity markets. The period of 2003-07 was an exception as a globally synchronized boom was underway and equity markets trended higher.
Of course, just the past trend does not make me believe that the VIX will increase leading to a decline in stocks. Apart from encouraging statements, there has been a lack of action by central bankers. The global economy is also on a downturn and the next 3-6 months will witness policy action to support the economy and markets. These events do lead to increased volatility and markets can correct from near-term overbought levels.
Factor #3: S&P 500 P/E Valuation
There are several reasons to believe that markets are overbought. Before I discuss that, I would like to mention that markets are not terribly overvalued when it comes to P/E valuation. The markets are currently trading at 14 times TTM earnings.
However, markets can correct after an 11% rally in the last two months in the absence of any significant positive cue. Markets are also trading at a four-year high, and it is concerning to see markets at these levels amidst a global slowdown.
Factor #4: S&P 500 Trading Volumes
Adding to concerns is the fact that the rally has been associated with declining volumes. I am not an expert technical analyst. However, I do understand that a market rally on low volumes is not a great sign.
Underscoring my point of near-term overbought markets are the next two charts.
The first chart gives the S&P 500 high-low index and the second gives the S&P 500 bullish percent index.
Factor #5: The S&P 500 High-Low Index
The S&P 500 high-low index is calculated by taking new highs divided by the new lows made in the S&P 500 index. The index has surged to 98.96 as of August 17, 2012, from a low of 43 in May 2012. Clearly, [as can be seen in the chart below,] there are a significant number of highs being made in the S&P 500 stocks compared to the number of lows. In general, this is a sign of markets topping out in the near term.
Factor #6: The S&P 500 Bullish Percentage Index
The S&P 500 Bullish Percentage Index [see chart above] also points to overbought conditions. In general, a reading of over 70 indicates overbought conditions and a reading of over 80 indicates an even stronger overbought signal. Currently, the bullish percentage index is exactly at 70.
While I believe the S&P 500 index will do reasonably well over the next 3-5 years the above 6 factors combined make a strong case for avoiding the equity markets in the foreseeable future. Long-term investors can still ignore the volatility and buy quality stocks, however, it would make more sense to buy the same stocks after the markets decline 10%-15% than buying it at current levels.
*http://seekingalpha.com/article/815251-exit-equities-as-vix-hits-a-5-year-low-and-s-p-500-index-a-4-year-high (To access the above article please copy the URL and paste it into your browser.)
Editor’s Note: The above post may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.
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