The Bulls are in Charge on Wall Street: 3 Key Indicators


The last few months have been super for the US stock market and for gold

Few thought in March that the S&P 500 would be back above 3,000, the DJIA would be back above 25,000 and the NAS would mark new all-time highs in late June.

As we roll into the Summer Doldrums there are signs of concern that could signal a coming slowdown in US stocks, but the trend is up and the Fed is backing the market.

I do not believe The China Virus fear mongering, it will be contained and there will be no more lockdowns.

I do not see the market getting Toppy and the resumption of a Bearish downtrend, but for sure I pay attention for any warning signals.

The Big Q: What is happening?

The Big A: I am seeing movement in 3 Key indicators: gold, the VIX, and the VIX/VIX3M relative-strength chart.

Gold is 1 of the oldest safe-haven assets. Traders see gold as a store of value because unlike fiat currencies, governments cannot just create more of it at will.

When traders cannot find yield, they are less concerned about the opportunity cost of moving their money to a non-yielding asset like gold.

The value of gold is driven by demand. When demand is high, the value of gold goes up. When demand is low, the value of gold goes down.

Demand for gold has been increasing because traders are worried about the damage that could be done to the US economy if states and cities reinstate or intensify their China Virus lockdown orders.

In fact, the price of gold is back above 1,700oz (see Fig. 1).

Gold is now trading just below 1,800oz. If you look at the weekly chart in Fig. 2, you will see that gold has climbed all the way back up to where it was trading in the wake of the Y 2008 Financial Crisis when the precious Yellow metal topped out at 1,923.70oz.

This tells us that traders are continuing to load their portfolios with safe-haven assets just in case the stock market takes a turn for the worse, the amount is 10-15%.

The VIX: the CBOE S&P 500 Volatility Index (VIX), aka the “fear index” because it is a helpful gauge to measure how worried traders are that the S&P 500 might suddenly drop within the next 30 days.

When the VIX starts moving higher, it is telling you that traders are getting nervous. When the VIX starts moving lower, it is telling you that traders are gaining confidence.

Looking at the daily chart of the VIX in Fig. 3, you can see that the index has broken through the down-trending resistance level it had been interacting with since mid-April and is showing signs of turning around by forming higher highs and higher lows.

Seeing the VIX start to move higher tells us that traders are becoming increasingly worried about the potential of the S&P 500 dropping in the near-term.

Contrarians believe when the VIX marks 40-42 it is a buy signal

VIX/VIX3M Relative Strength Chart

Most traders tend to just focus on the VIX, which is a measurement of the anticipated volatility being priced into S&P 500 options for the next 30 days, when they think about measuring trader sentiment.

But, sometimes focusing only on the next 30 days is not long enough. Sometimes it is helpful to expand your horizons out to the next 3 months. Summer Doldrums is 1 of thoses times.

When traders need a longer-term outlook, they can look at the CBOE S&P 500 3-Month Volatility Index (VIX3M), which is a measurement of the anticipated volatility being priced into S&P 500 options for next 90 days.

By comparing the value of the VIX to the value of the VIX3M, we can identify frames when trader sentiment has turned extremely Bearish and when it has normalized.

Because these volatility indexes measure the size of the price movement traders believe the S&P 500 may make during the measured time frame, the value of the VIX3M is usually higher than the value of the VIX.

Because, if we give the market 3 months to make a move instead of 1 month it has a greater chance of making a larger move.

Often, there are frames when traders will price in a greater chance of a larger move in the short-term than in the long-term because they are nervous the market is about to drop. This pushes the value of the VIX up higher than the value of the VIX3M.

The easiest way to compare the value of the VIX to the value of the VIX3M is to create a relative-strength chart of the indexes where you divide the value of the VIX by the value of the VIX3M.

The VIX/VIX3M relative-strength chart will have a value less than 1 because the value of the VIX is usually less than the value of the VIX3M.

During periods of high market stress, the VIX/VIX3M relative-strength chart will often have a value greater than one because traders are pushing the value of the VIX higher than the value of the VIX3M.

The Big Q2: Where is the VIX/VIX3M now?

The BigA2: The VIX/VIX3M is flirting with 1, meaning the VIX is starting to outpace the VIX3M.

The VIX/VIX3M closed above 1 on June 11 and has crossed above 1 4X since then during market hours.

This says that Bearish concern is moving higher.

The above warning signs are no more than potential Red flags now. As we have seen traders become concerned in the only to see that concern fade away on positive news.

Next week I will be watching the news signs that states and cities might start moving back toward stricter shelter-in-place policies because of the rising number of China Virus cases.

And, let us not forget Q-2 earnings season comes in a few weeks, which will provide a look into the health of corporate America.

Have a healthy weekend, Keep the Faith!

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