Thu Mar 06 2014
Live Index (1448 articles)

Market Outlook: Warning: ‘Fear Index’ Points to Potential Market Decline

The bellwether S&P 500 traded completely inside of last Monday’s trading range from Tuesday through Thursday of last week, indicating near-term investor indecision, before staging a tentative move to new all-time highs on Friday. Friday’s move to new highs, despite a sharp downward revision in Q4 2014 GDP and amid worries about Russian intervention in Ukraine, was an impressive show of bullish investor conviction and is characteristic of a market that wants to go higher.

Last week’s new 2014 high in the small-cap Russell 2000 index, matching those in the S&P 500 and in the tech-laden Nasdaq indexes, was another positive sign. However, as discussed here last week, both the Dow Jones Industrial Average and Transportation Index continue to lag and must also establish new 2014 highs to confirm and corroborate the recent strength seen in the rest of the market.

Improving Market Breadth = More Horsepower for the Trend

Despite the lagging Dow Jones indexes, there are also a lot of good things happening under the hood of this market — particularly on a near term basis. One of these is the positive shift in market momentum as indicated by the rising Moving Average Convergence/Divergence (MACD) indicator displayed and discussed in last week’s report. Another one is improving market breadth in the NYSE Composite Index, as plotted by the blue line in the upper panel of the chart below.

The red circle at the upper right edge of the chart shows that the percentage of NYSE Composite stocks trading above their 200-day moving average, after being stuck between 41% and 61% since June, rose to 66% at the end of last week. This means that the market is now being driven higher by a larger group of rising constituent stocks, which is analogous to a car going up a hill with more horsepower under the hood. As long as market breadth continues to improve, the U.S. broad market should continue its recent advance.

Watch the VIX for Signs of Trouble

With a packed economic calendar this week amid quickly escalating geopolitical tensions in Ukraine, there are plenty of potential potholes for the market to hit this week. One way to measure whether investors have collectively become nervous enough to temporarily reverse market direction is via the CBOE Volatility Index (VIX), which is plotted since September by the black bars in the lower panel of our next chart.

The red highlights show that a rise in the VIX above its 50-day moving average, indicating an increase in investor fear, has coincided with the past three minor declines in the S&P 500 (upper panel). The VIX has been hovering just below its 50-day moving average, currently situated at 14.57, for the past week, indicating investor complacency, as the S&P 500 has moved cautiously higher. Accordingly, I would view a rise in the VIX above 14.57 this week as a warning that the market is collectively becoming frightened enough to trigger another similar minor decline.

Asset Flows Support Higher Gold Prices

Two weeks ago, I pointed out that the CME (formerly COMEX) gold contract had risen above its 200-day moving average, a widely watched major trend proxy, for the first time in a year and said this suggested an emerging major bullish trend change in the price of the yellow metal.

Since then, gold prices have risen by an additional $ 46 per ounce, or 4%, to as high as $ 1,346 last week. How high can gold prices go? One way to tell, from a near-term perspective, is by watching investor asset flows.

The black bars in the lower panel of the chart above plot the SPDR Gold Trust ETF (NYSE: GLD) daily since July 2013, with its total daily assets plotted by the blue line in the upper panel along with their 21-day (monthly) moving average. The green highlights on the right side of the chart show that these investor assets expanded above their monthly moving average in mid-January, which fueled the current rise in GLD and indirectly in gold prices, which this ETF emulates. The green highlights on the left side of the chart show that a similar expansion in investor assets fueled the previous significant rise in GLD during August of last year. As long as these investor assets continue to expand, expect the recent rise in gold prices to continue.

Putting It All Together

Although the U.S. stock market has tentatively been extending its 2013 gains thus far in 2014, the recent rise in both gold and long-dated U.S. Treasury prices suggests a subtle defensive shift in investor assets that is characteristic of an apprehensive market. I would view an appreciable rise in the VIX this week as more evidence of investor nervousness which, should this occur, would likely have an adverse effect on the U.S. stock market.

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