WATCH OUT FOR THE VIX -- VOLATILITY IS RISING FOR THE FIRST TIME IN TWO YEARS WHICH IS BEARISH FOR STOCKS

THE VIX IS RALLYING ... The CBOE Volatility Index (VIX) is starting to climb. Chart 1 shows the VIX trading at a two month high and nearing a challenge of its 200-day moving average. A more important test will take place at its January high at 14.75. That's because the VIX has been dropping in a pattern of descending peaks and troughs for two years. A move above its January high would reverse that pattern. That would be negative for the stock market since a rising VIX is usually associated with a falling stock market. Interestingly (or ominously), it's been exactly two years since the market bottomed and the VIX started to drop in March 2003. There's another reason why a VIX move to a new 2005 would be very significant. That reason is shown in Chart 2.

Chart 1

VIX NEARING TEST OF MAJOR DOWNTREND LINE... The weekly bars in Chart 2 show the entire decline in the VIX that started in October 2002 (as the stock market started to bottom). The VIX dropped sharply in March 2003 (see down arrow) as the market started a major upleg. I've drawn a major down trendline touching as many of the peaks as possible (using a log scale). It shows that a VIX move to a new 2005 high would break that long-term resistance line. Chart 3 shows why that would be bad for the stock market.

Chart 2

VIX BOTTOMS ARE ASSOCIATED WITH MARKET TOPS... Chart 3 compares the VIX (purple line) with the S&P 500 (black line) for the last six years. The main point of the chart is to show that they normally trend in the opposite direction. Notice that important peaks in the VIX are associated with bottoms in the S&P. The last two took place in late 2002 and the spring of 2003 (see green arrows and circle). The cyclical bull market in stocks over the last two years has been accompanied by a falling VIX which is the normal historical pattern. Important bottoms in the VIX, however, are usually associated with market peaks -- as in 2000 (see red markings). Which brings us to the present. If the VIX is bottoming, that would be another argument that the stock market is peaking.

Chart 3