ANOTHER MEASURE OF VOLATILITY FLASHES A WARNING -- MARKET FALLS ON RISING VOLUME AND MAY HAVE ENDED SHORT-TERM BOUNCE

VIX CONTINUES TO CLIMB ... We've produced a number of articles recently showing the CBOE Volatility (VIX) Index climbing to a new two-year high and warned about the danger that poses for the stock market. That's because the market usually trends in the opposite direction of the VIX. Chart 1 shows last week's pullback bouncing off its January peak and climbing back over 18 in today's trading. Today's surge in the VIX accompanied heavy stock market selling. I'd like to show another measure of volatility today that's also flashing some warning signals.

Chart 1

BOLLINGER BAND WIDTH SURGES... Chart 2 applies Bollinger bands to a daily chart of the S&P 500. If you look to the far right, you can see the two bands diverging very noticeably over the last month. There's an easier way to view that and that's by plotting Bollinger Band Width which is shown at the bottom of the chart. [You can find that indicator near the bottom of the Stockcharts indicator list]. As the name implies, Bollinger Band Width plots the difference between the two bands. In general, narrow bands imply a market with low volatility. That often accompanies a pullback or consolidation in an ongoing trend. Wider bands imply rising volatility. That usually happens when a new trend is starting. In most cases, that new trend may be only short-term in nature. The spread between the two bands, however, has spiked to the highest since the start of 2005. The chart shows two previous S&P selloffs that took place last spring and last fall. The fact that band width has exceeded both of those previous highs suggests to me that the current selloff is more serious that anything that's occurred over the last eighteen months.

Chart 2

DIVIDEND-PAYING STOCKS HOLD UP BETTER ... I wrote a couple of articles last week about how investors start to favor the Dow Industrials when they get nervous about the market. The same is true for dividend-paying stocks. The next chart plots the Dow Jones Dividend Index iShares (DVY). That ETF includes stocks that pay the highest dividends. The highest weightings are in consumer staples, financials and utilities which are also considered to be defensive in nature. The most important line in Chart 3 is the relative strength ratio of the DVY versus the S&P 500 over the last year (blue line). The line had been dropping since last summer (as the market rallied). The ratio turned up, however, during the month of May as the rest of the market started to fall. That's a traditional response of nervous investors. It's also another sign of a market that's now on the defensive.

Chart 3

MAJOR MARKET INDEXES STILL LOOK WEAK... Today's market downturn (in heavier trading) may have ended the short-term bounce that started last week. That wouldn't be too surprising considering that weekly technical indicators are still on a sell signal. The next three charts put the day's downside action into some perspective. The Dow Industrials have held up better than the others during May (Chart 4). However, the Dow failed a test of its 50-day moving average today. That's suggests that another test of its late April low may be imminent. Chart 5 shows the S&P 500 bearing down again on its 200-day moving average. The black line beneath the chart is the 12-day Rate of Change (ROC). It's measure of market momentum. It's already fallen beneath the lows formed last October. To me, that's a sign of more selling to come. Chart 6 shows the Nasdaq Composite which has been the weakest of the major market indexes all year and again today. It's still trading well beneath its 200-day average. The daily MACD lines beneath Chart 6 are not only still negative, but have undercut the lows of last October. That's another negative sign as is the fact that the Nasdaq continues to drag the rest of the market lower. [Today's biggest losses came in the Nasdaq and small caps stocks as well as basic materials. Emerging markets lost another 4%. That shows that investors are still selling their riskier holdings].

Chart 4

Chart 5

Chart 6