Trades and Transitions

Overall our indicators match the market’s striking lack of volatility. Except for the -2 for oil stocks, and the -1 for oil, they all are in stasis mode at zero, what we would characterize as a “do nothing” setting. Our indicators go back to the early part of the new century, and while we don’t keep data on the variations among them, a “by eye” inspection suggests the current period is unique in its lack of variability.

Going along with this lack of variability among our indicators are the near-record lows in the closely watched Vix ratio, which is a measure of expected volatility. Keep in mind, though, that it is best seen as a technical definition, because the low option premiums that define the ratio result from and reflect past levels of volatility.

While Vix typically refers to stocks, and in particular to the S&P 500, there are comparable measures for other markets. Not surprisingly, given that so many markets are related to the stock market, the Vix for other markets such as bonds is comparably low. That, again, is consistent with our indicators.

Unfortunately, all this makes it very difficult to find good trades. But it’s important to keep in mind the above point that while Vix ratios, whether for bonds, stocks, or gold, are interpreted as projections of the future, they are based on the past. And history tells us that the past is not a great predictor of the future.

That’s because everything about markets is cyclical including both their volatility and their trends. And when trends go to extremes, the reversal is often very sharp. What you see is not likely to be what you will get.

We would love to be able to say that our indicators invariably catch inflection points – such as the change from very low volatility to high volatility – but very often they are either a little early or a little late. And the reason, especially when they are a little late, is that inflection points arise from out-of-the-blue events, typically an unexpected change in government policy or an unexpected bankruptcy.

Fortunately, history shows that occasional errors notwithstanding, the indicators do catch the lion’s share of both gains and losses once trends are established. Errors are most likely to come during transitions. That could be in the neighborhood of where we are now, given that the market seems overdue for a transition. The bottom line is that we will continue to make as many trades as possible but will be willing to overrule our signals if we sense a transition is beginning.

 

 

Stock Talk

Add New Comments

You must be logged in to post to Stock Talk OR create an account