In addition to classic technical analysis such as trend and moving average work, I like to look at macro (long termed) signals that can provide a heads up for potential risk in the months ahead.
- Long termed signals include: sentiment, breadth, VIX and (dare I say it) valuation metrics like PB and PE ratios.
- Short and mid termed signals include: momentum oscillators, % stocks over MA’s and NHNL indictors, money flow and comparative relative strength.
Today I’d like to cover 3 longer termed indicators that may suggest trouble in the months (not weeks or days!) ahead for markets. Lets get right into them:
Dow Theory: INDU vs. TRAN
Dow Theory contains a tenant that Ii rely on as one of my breadth indicators. That is, the comparative movement between industrial stocks and their transportation counterparts. For longer termed readers of this blog, you know that I have cited divergence (opposite trends) of these indices on a few occasions in the past, and these divergences (in conjunction with other macro indicators) are very accurate in predicting market trend changes. The current trend appears to be changing for the transports, while the Dow Industrials keep pushing to new highs. As you will note on the chart below, this does happen periodically–and when it does, it can be ominous of a correction- although it is a very leading indication.
Sentiment: Smart vs. Dumb Money
I look at plenty of sentiment indicators. But if you put a gun to my head and told me to choose my favourite, it’ll always be the “Smart/Dumb” money compilation of surveys that sentimenTrader puts together. Right now, their proprietary indicator shows us that Dumb money (red line) is buying, and Smart money (blue line) is selling. This is another leading indicator, and you want to see the two sides reach their respective extremes before panicking – but its getting darned close!
Volatility: The VIX
This is a really, really big picture indicator. Note on the long termed chart that the VIX indicator can stay in my observed extreme zones for months – and even years – at a time. But you’ll also want to note that the markets cannot – absolutely will not- remain there forever. When the VIX gets into the extreme “low volatility” zone of around 11, for example, its not going to stay there forever. Markets will correct, and the VIX will spike. And its getting closer to that point.
BTW-its kind of a no-brainer to buy the VIX in some form or another if it does get into the 11 zone. Historically, its seen spikes down to just below 10, but that appears to be the maximum downside–compared to the maximum upside of 35+ in an extreme market reversal. After all, volatility cannot completely disappear and go to zero. So a trade from 11-ish in a VIX investment seems to be a good market hedge, and a profitable opportunity for those who are looking for a good risk/return investment. It’s not there yet, given its current level of 13.5, but it’s getting closer….