VIX views on where the S&P 500 and equity markets are headed

Here's how my VIX chart looks right now. The volatility index is above its 50-day moving average. So even though it's weak today, that can actually continue for a few days to test back to that key moving average - and that's all it would be, a test. Getting support at that 50-day moving average can propel the VIX higher. In fact, the VIX wouldn't have to get much above yesterday's high in order to point toward that 66.46 level that I've identified (or even above that). Obviously that would be bearish for equities. So, you already know, if you have been reading here, that the cycles work from ChartsEdge as well as from Andre Gratian posted this weekend, that there's upside potential for the markets this week. What are these VIX indicators, cycles and Elliott Wave saying about market action after this week?

While I cannot give you a preview of what the cycles folks are saying about next week, I can point out that the Elliott Wave work of both Tony Caldaro and myself is indicating that the markets are likely to continue lower. And I've outlined potential targets for that based on long-term Fibonacci (levels like 640, and under that as well, in the S&P500) ... and Tony's outlined some levels, as well as Andre having done so in his weekly updates posted here. Plus, I've shared the info from Terry Laundry's public work posted at his T Theory site (all these sites, included in the "other sites of interest" at right side of this page). And I've mentioned the "complacency divergence" (my term for it) that's occurred in the VIX and has been continuing for some weeks now. By complacency divergence, I'm referring to the VIX being relatively lower than it was in October and November 2008, even as the markets didn't rally commensurately off those lows, and for that matter have demonstrated weakness since January 6.

Another of the other sites of interest I keep listed on this page and to which I refer every Monday, is Schaeffer's where I particularly enjoy reading what Todd Salamone and Rocky White discuss each Monday. So I hope no reader of this blogsite will be surprised if a rally this week fails to have more upside followthrough after this week.

Here is a quote of some of those good analyses by Todd and Rocky at that SchaeffersResearch.com site yesterday:

Wall Street Faces November Lows Without November Fears
What the Trader Is Expecting in the Coming Week: Is There More Risk Now Than in November 2008?
By Todd Salamone, Schaeffer's Senior Vice President of Research
"There are not that many sellers left. The last thing you want to do is sell."- Jim Paulsen, Wells Capital Management, AP/USA Today, Feb. 20, 2009
"It's a big mistake to make any sudden moves... Active investors are their own worst enemies in that when the market declines significantly they bail out and typically what happens is they miss the rebound."- Boyce Greer, president of Strategic Advisers Inc. and head of global asset allocation at Fidelity Investments, Fidelity Interactive Content Services, Feb. 20, 2009
"The number of fund managers predicting that the global economy will worsen over the next 12 months has fallen to the lowest level since the onset of the credit crisis, according to a survey by Merrill Lynch. The monthly survey, which polls 177 institutional investors controlling a total of $599bn in assets, showed those forecasting a deteriorating economy over the next year falling from 60 per cent last October to 6 per cent in February, the lowest level since July 2007."- Financial Times, Feb. 17, 2009

With the Dow Jones Industrial Average (DJIA) now trading below its November 2008 lows and the S&P 500 Index (SPX) hovering just above its November 2008 closing low, I thought it would be interesting to assess whether or not sentiment has changed during the past 3 months. In other words, have we finally witnessed panic selling, and are we seeing the despair that usually marks bottoms?
Anecdotally, and as expressed in the quotes above, it is evident that little has changed from a sentiment perspective. Thus, what we said last week still holds true today: "Unlike some who 'fear missing a rally,' we fear for those who have too much riding on an upside move before another major break to the downside occurs."
Sure, there is some fear out there. During the past week, we saw a few technicians warn that the market still has not reached a bottom. For example, a front-page article in The Wall Street Journal on Friday offered the headline, "Market Hits New Crisis Low," with the subtitle: "Dow Is Now 47% Below Its Peak; Analysts Warn They See Few Signs of a Bottom." The article quoted bearish technicians, and was very similar to an August 2002 article in The Journal titled, "Was It Just a False Bottom? Experts Fear Answer Is Yes." Indeed, the market was carving out a bottom in 2002 when the article appeared, but it would be months before the rally finally began.

When comparing the current sentiment landscape with the one from 3 months prior, it could be argued that the market is currently in worse shape, despite the SPX trading at similar levels. Why? Because there is less fear in the market than there was just 3 months ago. In late November 2008, we saw short-term pessimism creep into the market. This negativity was eventually unwound, as investors pushed the market higher in anticipation of positive changes from the incoming Obama administration. Now, some of the sentiment measures that we track are either on par with or not as pessimistic as those taken during the November bottom. Moreover, unlike late 2008, investors have little to look forward to in terms of anticipating positive news, other than comments late last week in which the White House sought to counter rumors of bank nationalization.

In fairness, the comparatively low VIX level could be attributed to retreating historical volatility in the SPX. For example, when the VIX hit 80.86 on Nov. 20, the 20-day historical volatility on the SPX was at 72.29. With the VIX coming into this week at 49.38, the 20-day historical volatility is at 32.47, indicating that those seeking portfolio protection are paying much higher prices relative to the SPX's historical volatility. That being said, the small upside move in the VIX, as compared to the huge, swift move lower in the market, is something to think about.


Whereas the VIX surged in November amid market weakness, a concern would be for those who sought portfolio protection via the purchase of VIX calls. To the extent that this hedge is not working out as anticipated due to a relatively muted advance in the VIX, investors who thought they had portfolio protection with the VIX calls are not being compensated. Therefore, they may be feeling more pain now than in the past. This could result in an increased incentive to reduce long exposure or ante up on more portfolio protection, thereby pressuring stocks.

That said, the bears should acknowledge that there is a strong short-term bid near the 750 level on the SPX. The index also comes into this week oversold, according to its 9-day Relative Strength Index (RSI). Moreover, just as one of last week's risks was the support at the 160-day moving average for the VIX, we enter this week with the VIX sitting just below its 80-day moving average, which has capped upside moves in the VIX in 2009. If the 80-day moving average indeed capped last week's advance, we could see a bounce higher in the immediate days ahead. Should this be the case, short-term resistance on the SPX resides at the round-number 800 level.

Indicator of the Week: Investors Intelligence Poll Signals Caution
By Rocky White, Schaeffer's Senior Quantitative Analyst

Foreword: The Investors Intelligence (II) Poll gauges market sentiment by reviewing numerous publications on investing in the stock market. II then reports the sentiment expressed in these surveys in terms of percent bullish and percent bearish. Here at Schaeffer's we watch this poll, among others, in order to decipher where the crowd stands relative to where the market is. With the S&P 500 Index (SPX) heading toward its November lows, we thought it would be a good time to review what this sentiment poll looked like at prior market bottoms.

Current Reading: Remember that we take a contrarian view to these sentiment readings. Historically, the best time to buy is when pessimism is rampant, while the best time to sell is when investors are extremely optimistic. With the market performing so horribly during the past 15 months, you can expect a lot of pessimism. However, has the pessimism peaked?

Comparing data from II surveys with market performance for the past several months, the SPX and the percentage of bullish responses to these surveys have tended to decline in tandem. However, what has us a little concerned is the recent decline in the percentage of bearish respondents to the II survey. Specifically, the SPX is very close to its November lows, and we would expect the bullish percentage, not the bearish percentage, to be at extreme lows. But that is not the case, as optimism has actually crept upward in recent weeks.
Prior Readings: The recent action in the Investors Intelligence poll prompted enough concern that I decided to revisit prior market bottoms and see how the poll behaved during those times. Looking at the period between 2002 and 2003 when the market last bottomed, the SPX and the II's sentiment reading formed 3 main troughs. The first appeared in late July 2002, followed by a small rally and a plunge to fresh lows. When the market hit that new low, the percentage of bullish investors also hit a fresh low reading. Finally, the third trough falls near the low but never quite reaches it. It is important to note that the bull/bear sentiment reading hit a higher low before the market rebounded.
Pulling back for a look at the same readings in the early 1990s, the market and bull/bear reading dropped initially, as pessimism increased as expected. The market then rallied before falling back to new lows. This time the bull/bear reading drops back to its previous lows. This point marked the SPX's bottom and a peak in pessimism for the II sentiment readings.

Implications: The past 2 market bottoms were marked by peaks in pessimism, as measured by the bull/bear percentage readings from the Investors Intelligence poll. We are now near the market lows that were reached in November 2008, but pessimism has not reached a corresponding peak. As such, we should remain cautious on the market. I would like to see market lows met with peaks in pessimism, and will certainly be keeping an eye on these readings in relation to market action.

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Folks, I cannot always post so much in the way of quoting from their Monday Morning Outlook articles. So, I commend them to you, always a good read every Monday at the SchaeffersResearch.com website for good context on market perspective. This also helps you in interpreting the ISEE (as well as VIX) information that we post here periodically.