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David Moenning is a the Chief Investment Officer at Heritage Capital, which focuses on active risk management of the U.S. stock market. Dave is also the proprietor of, which provides free and subscription-based portfolio services. Dave began his investment career in 1980... More
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Daily State of the Markets
  • Has The VIX Issued An Important Sell Signal? 0 comments
    Jun 11, 2014 8:06 AM

    Daily State of the Markets
    Wednesday, June 11, 2014

    Back in March, we spent some time exploring how investors could use the VIX in order to help them determine safe entry points in the market after corrections. We looked at a couple of different buy signals that were tied to the VIX. As we discussed a really simple approach to identify turning points in the market after a correction is to wait for the VIX to first spike and then reverse lower.

    After looking at an admittedly simplistic approach, we then did some math and took the idea a bit further. We looked for a way to define extreme moves in the market and reviewed what happened when the VIX first moved more than 2 standard deviations above its 20-day moving average and then reversed. In the article, we wrote that the move above the 2 standard deviation line told us that the market had experienced a meaningful correction. And then, when the VIX moved back below the two standard deviation line, it told us that volatility had begun to retreat. This meant that the correction in stock prices had likely run its course.

    History shows this to be a pretty effective buy signal and the statistics on the buy signal were impressive. However, we noted at the time that while this was a pretty darned good buy signal, it did not work quite as well on the sell side.

    In Search of a VIX Sell Signal

    Given that everybody and their grandmother has been yammering on lately about the low readings seen on the VIX, we thought it might be a good idea to look a little harder at our research to see if we couldn't come up with a sell signal that might be useful.

    To be sure, the VIX has been moving lower in recent months. In fact, the weekly chart of the VIX shown below illustrates that the current reading is the lowest since early 2007.

    VIX - Weekly

    In looking at the data, it is worth noting that turning the buy signal discussed on its head in order to produce a sell signal isn't too bad.

    Since 1995, the S&P 500 moves down -0.09 percent on average 5 days after a sell signal is given. This represents a pretty good departure from the average return for all 5-day periods in the sample, which is +0.18 percent.

    Ten days after a sell signal, the market is -0.03 percent lower, which, again, compares pretty well to the average return of +0.35 percent for all 10-day periods.

    However, the problem is that when the bulls get on a roll to the upside, this type of system gives signals that are oftentimes VERY early. As such, one winds up missing some of the biggest moves to the upside. And this is simply unacceptable.

    Looking For Clumps of Signals

    While there isn't that much data to review, it does appear that there is an answer. You see, when stocks start to enjoy a serous joyride to the upside - a move that tends to defy logic - this indicator will occasionally fire off several sell signals in close proximity to each other. This tells us that the market is overbought and that the uber-low reading of the VIX suggests that things have gotten a little frothy.

    So, while a single sell signal from this indicator during a serious uptrend should be ignored, if three or four signals come bunched together - well, now we're talkin'.

    The chart below shows the S&P 500 plotted weekly with arrows depicting the times when "bunches" of our VIX sell signals occurred.

    S&P 500 - Weekly

    Again, there isn't that much data to review on this chart. However, you have got to admit that the arrows in 2010, 2011, and 2012 were, at the very least, pretty good warning signs, right?

    In 2010 there were 5 sell signals clumped together about two weeks before the ultimate top. In 2011, there was a clump of 3 signals that occurred just as the market peaked out. And then in 2012, there were actually two clumps of 3 signals before the decline began in earnest.

    So, what's happening now, you ask? While this is admittedly not a terribly scientific system and my analysis isn't exactly rigorous, it is worth noting that our little VIX indicator has fired off 4 sell signals in the last two weeks, which in my book is the very definition of a clump. And the most recent signal occurred... wait for it... yesterday.

    So, will stocks begin a decline tomorrow or the next day? Frankly, there is NO way to tell. However, given what has transpired after clumps of sell signals since 2010, this is an indicator that might just bear watching in the near-term - especially if the bears can come up with some sort of bad news with which to work.

    Publishing Note: I am traveling on business the rest of the week and will not publish a morning report. Regular "State" reports will return on Monday.

    Looking For Investment Management Help?

    If you are looking for help with money management, check out Heritage Capital Management's Active Risk Manager Service - or call Heritage for more information at (630) 250-4700.

    ALL NEW: The Next Generation of the Daily Decision system is now available to clients of Heritage Capital. The upgraded system utilizes swing trading and mean reversion strategies during neutral market environments, multiple indices for long positions, incremental moves in and out of the market, multiple managers and multiple strategies - with the overall goal being reduced volatility, fewer and less impactful whipsaws, and a "smoother ride." To learn more about the "Next Generation" system, Read the Research Report

    Turning to This Morning...

    Three developments this morning may be able to put the bears back in the game. First, the Chinese announced that they will keep monetary policy stable throughout the remainder of 2014. Next, the World Bank lowered its projections for global growth in 2014 again. And finally, House Majority Leader Eric Cantor's stunning primary loss suggests that the relative calm seen in Washington of late is about to end. So, with Europe bourses in decline, U.S. stock futures are pointing to a lower open on Wall Street.

    Pre-Game Indicators

    Here are the Pre-Market indicators we review each morning before the opening bell...

    Major Foreign Markets:
    - Japan: +0.49%
    - Hong Kong: -0.25%
    - Shanghai: +0.12%
    - London: -0.60%
    - Germany: -0.97%
    - France: -0.85%
    - Italy: -1.04%
    - Spain: -0.69%

    Crude Oil Futures: +$0.09 to $104.44

    Gold: +$2.60 at $1262.70

    Dollar: higher against the yen, lower vs. euro and pound.

    10-Year Bond Yield: Currently trading at 2.627%

    Stock Futures Ahead of Open in U.S. (relative to fair value):
    - S&P 500: -7.94
    - Dow Jones Industrial Average: -63
    - NASDAQ Composite: -16.61

    Thought For The Day...

    We are all lying in the gutter, but some of us are looking at the stars. - Oscar Wilde

    Positions in stocks mentioned: none

    Follow Me on Twitter: @StateDave

    The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.

    Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

    The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

    The information contained in this report is provided by Ridge Publishing Co. Inc. (Ridge). One of the principals of Ridge, Mr. David Moenning, is also President and majority shareholder of Heritage Capital Management, Inc. (OTC:HCM) a Chicago-based money management firm. HCM is registered as an investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Ridge is a publisher and has not registered as an investment adviser. Neither HCM nor Ridge is registered as a broker-dealer.

    Employees and affiliates of HCM and Ridge may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Editors will indicate whether they or HCM has a position in stocks or other securities mentioned in any publication. The disclosures will be accurate as of the time of publication and may change thereafter without notice.

    Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

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