The market is making a significant move higher during these first days of January. The S&P has finally broken over a technical barrier at 1280 which it has had a lot of trouble staying above since the late summer. On two occasions it broke 1280 just to head back lower. If this move it to be sustained, then several closes above the 1300 level need to be recorded, otherwise we may head back lower again.
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It’s earning season and that could account for some of the optimism in these early days. Warnings are not as bleak as expected and despite the horrible news coming out of Europe, the trend right now is higher. The obvious question is whether it can last. For that answer we need to look at the Volatility Index, or the VIX.
The VIX is now just above 20, less than half of what it was a couple of months ago. This is signaling that investors are less bearish, buying less put options on the S&P 500 for protection. A move below 20 followed by several closes below that level would confirm this move as real.
Of course, it seems to defy common sense that the market should be rising at a time when we have political uncertainty, and economic uncertainty. Many will credit the move to the market “climbing the wall of worry” or the “January Effect”. Don’t buy it. The reason is a lot simpler.
Investors and money managers are faced with the stark reality that cash is paying nothing now as it has done for more than three years now. That loss of a cushion is forcing many to deploy capital into the market. It’s what the Federal Reserve intended by forcing investors into risk assets like the stock market. It is for this reason that any move higher in the current environment might be short lived. The move we are seeing is not based on fundamentals, but on fear. Fear of not making returns on our portfolios.
You need to be even more careful today, even though you might be breathing a sigh of relief that stocks are not cratering while there are clarion calls of a major recession in Europe, unacceptable rates of unemployment in the US, a slowdown in some emerging markets and a very nasty political battle brewing for the Presidency of the United States.
Lower volatility should also be reflected in lower premiums being paid for options on the major indices. That is simply not the case. S&P options are still pricey when you go out a few months with bids for options with strike prices 20% to 30% below current levels.
Interpreting the market right now, I would have to say that it is still a traders market and not one for log term investors looking to park capital. On the surface the VIX is pointing to better times ahead and lower volatility, but beneath the surface there is still significant anxiety. Sometimes, indicators like the VIX prove to be wrong in the very short term as more buying and bullishness can cause the indicator to move lower. It is what happens over a period of time that will determine whether this is a good time to invest. Missing that initial move in a bull run is not as important as catching the real move if one is to occur. And, that is why it’s important for the S&P to confirm by closing above 130 for a few days and for the VIX to confirm by closing below 20 for a few days. This market is still jittery below the surface and unexpected bad news from a couple of market heavyweights, especially in the financial sector could send us south in a hurry.
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