VIX SPIKE IS ANOTHER CAUTION SIGNAL FOR THE MARKET -- THE S&P 500 IS TESTING ITS 200-DAY LINE AND LOOKS OVERSOLD
VIX HITS ONE-YEAR HIGH ... The market has something else to worry about. The CBOE Volatility (VIX) Index jumped to the highest level in a year. In so doing, it exceeded the previous peak hit in January and, at one point today, the peak hit last October. That's a potential problem because the market and the VIX usually trend in opposite directions. Chart 1 shows the inverse correlation between the VIX (red line) and the S&P 500 (green line) since the bull market in stocks began four years ago. The chart shows that the VIX peak in October 2002 coincided with a bottom in the S&P. The VIX has dropped throughout the four-year market uptrend. However, this week's rise has broken the four-year down trendline and suggests that the VIX may be starting to trend higher.
Chart 1
LONGER-RANGE HISTORY OF THE VIX ... Not every spike in the VIX has produced lower stock prices. But the record isn't encouraging for market bulls. The red line in Chart 2 shows the Volatility Index over the last seventeen years. The green line is the S&P 500. The five red arrows show spikes in the VIX that corresponded to significant market downturns. That includes the two bear markets in 1990 and 1994, the 1998 market correction, the 2000 market top, and another downturn at the start of 2002. The upturn in the VIX starting in 1996 and lasting until 1998, however, did not cause a market downturn. So here's the record. We've seen six previous spikes (or bottoms) in the VIX over the last seventeen years. Five of them coincided with market downturns. One didn't. That's a five out of six track record. While it's possible that this spike could be an exception to the rule, I wouldn't bet on it. The VIX is also bouncing from a long-term support level at its 1994 low. That suggests that the VIX could be putting in a major bottom. If it is, that's not going to help the stock market.
Chart 2
S&P 500 IS ENTITLED TO A BOUNCE ... Although the longer-range chart picture has weakened (with most weekly indicators on sell signals), the S&P 500 has lost about 5% this week and looks to be in a short-term oversold condition. Its daily chart shows the 9-day RSI line below 30 for the first time this year. In addition, the S&P has reached its 200-day moving average and potential chart support along its first quarter lows. That may be enough to cause a market rebound next week. If one does materialize, the first level of resistance would be at 1280 which would also be a one-third retracement of the recent selloff. That's also the mid-April low that was broken this week. Broken support levels often become new resistance levels. While short-term indicators are oversold, weekly indicators aren't. Since weekly indicators take precedence over daily ones, I would continue to view any short-term rally as another selling opportunity.
Chart 3
Chart 4
THE VIX IS OVERBOUGHT ... In keeping with our comparison of the VIX Index with the S&P 500, the daily bars in Chart 4 show the VIX Index pulling back from a short-term overbought condition. That's shown by the 9-day RSI oscillator moving over 70. The VIX is also trading back below its October peak near 17 after breaking it earlier today. A short-term VIX pullback from that level should coincide with a short-term bounce in the S&P 500. The bigger question is what happens after that.
