|Signs point to short but nasty bear market|
The Chicago Board Options Volatility Index, or VIX, measures near-term volatility conveyed by S&P 500 stock index option prices.
Often called Wall Street's fear gauge, it rises to reflect investor fear and falls when players feel less inclined to buy options to manage their stock market risk.
The VIX sank on Monday ahead of a host of market-moving events this week, including the final meeting of the Federal Reserve Board this year.
As U.S. stocks continued to move higher, the VIX, a contrarian indicator, slumped 11.27 per cent to 10.71 — a level not too far from last month's multi-year low of 9.9.
By Wednesday, the VIX was down to 10.18, implying bullish investor sentiment despite the risk of a correction with most of the broader North American indices trading at or near five-year highs.
This historic low of the fear gauge indicates high investor complacency.
As well, the month of December has a lot to do with rising stock markets and investor complacency. That is because major stock market corrections rarely occur during the month, a year-end bonus time for many money managers.
According to my historical data, there has been only one negative December over the past 16 years. Over the same period, a positive December has been followed by five negative Januaries.
Based on the VIX and other technical evidence, I can now go out on a limb and predict a negative January, which could in turn introduce a short but nasty bear with a target low in March 2007.
My March low target is linked to the most recent Federal Open Market Committee decision to leave the key interest rate unchanged due to "substantial cooling" in the housing sector, which in turn heightens the perception that the Fed will lower the U.S. benchmark next year — probably in March.
Some of the other technical evidence can be seen on our chart this week as we plot the weekly closes of Canadian National Railway Co. and weekly closes of the TSX Group Inc.
CNR is an important bellwether in that the railway it is a proxy for the North American economy, while the TSX is a proxy for trading volume in Canada's largest stock exchange.
The technical problem with both indicators is their failure to post new 52-week highs in spite of the recent highs of the broader North American indices. CNR is just above its 40-week moving average, but the moving average is turning downward. The TSX is in worse shape, now trading under its 40-week moving average while its moving average is also pointed downward.
The other technical problem is the failure of the Dow Jones transportation average to break firmly above the old May 2006 peak of 5,020 and "confirm" the recent 52-week high of the Dow Jones industrials. The Dow transports seem to be predicting slower growth in the North American economies.
When we look at the 20 components in the Dow transports we see problems. The top seven names by weight are FedEx Corp. (delivery services), Union Pacific Corp. (railway), United Parcel Service Inc. (delivery services), Burlington Northern Santa Fe Corp. (railway), Overseas Shipholding Group Inc. (marine transportation), Ryder System Inc. (transportation services) and Norfolk Southern Corp. (railway).
None of these companies is trading at or near 52-week highs.
Only three of the 20 components — all airlines: AMR Corp., Continental Airlines Inc. and JetBlue Airways Corp. — are trading at such highs.
Last week I wrote that no one knows how the bear will behave. Will it be a nasty, short drop, as in the 1998 Asian currency crisis bear, or will it be a long slow agonizing bear like in 1973 and 1974?
Cycle expert Ian Notley has produced a study of "short fast bears" over the past century. His observations are as follows:
1923 7 months
1934 5 months
1961 7 months
1979 6 months
1987 2 months
1990 3 months
1994 3 months
1998 2 months
If you think you can trade your way though those probabilities, be my guest.
The prudent strategy is to prepare for a bear by making sure you are properly diversified.
Bill Carrigan is an independent stock-market analyst. His Getting Technical column appears Fridays.