The S&P 500 (SPX) and the Nasdaq 100 index (NDX) fell today during the most significant degree of selling activity in over a month. Despite these moves, the indexes showed enough buying to bring their close into the upper half of today's trading range. This is more likely to be a bullish signal, as it shows investors are willing to step in and buy up any kind of dip right now.
However, a subtle undercurrent of concern is building in the options markets, where the CBOE Volatility Index (VIX) has begun to show a break in its normal pattern of inverse correlation. The chart below shows that the VIX usually maintains a strict inverse correlation with the SPX, but on rare occasions when the correlation seems to diminish or completely reverse, the event becomes a significant marker in time, from which the market may reverse its course over the short term.
The current reading of this correlation is actually much higher than normal. (Click on the chart to see an enlarged version of the graphic.) This could portend an extended sell off in the not-too-distant future.
Bond Markets Not Worried About Stock Market Instability
If the market were to have an extended period where prices fell and investors did more selling than buying, it would be useful to have some indication of whether it could turn into a full-blown bear market or not. The 20% decline that the major indexes showed at the end of last year could just have easily led to a major market decline – instead, it produced one of the best buying opportunities of the decade.
While no indicator calls every market turn perfectly, professional analysts agree that intermarket indications tend to precede such turns more often than not. Under such circumstances as we observe in the stock market, it becomes useful to review what alternatives investors have and where they might take their money if stocks became a disappointment. This includes bond markets and precious metals.
An interesting analysis of the bond markets can be found by observing the degree of correlation between bond prices as tracked by iShares' 20+ Year Treasury Bond ETF (TLT) and interest rates as tracked by CBOE's 10 Year Treasury Note Yield Index (TNX). These two instruments are expected to be inversely correlated. When they diverge from that inverse correlation, it becomes a potential indicator of change (see the areas marked on the chart). The current level represents an extremely tight inverse correlation, so the bond markets are not poised to change from a downward trend to an upward trend any time soon.
Gold and Silver Markets Remain Steady
If investors didn't want to buy bonds or simply move their money to cash, they might consider buying precious metals. If so, we would expect to see a jump in demand for gold or silver during a period of time when stock prices were falling. During such conditions, the price of gold and silver may not rise in carefully coordinated ways. Therefore, observing the correlation between gold and silver prices can be useful in determining major market turning points.
The chart below compares the price of gold as tracked by State Street's gold-tracking ETF (GLD) with the price of silver as tracked by iShares' silver-tracking ETF (SLV). You can see that these price patterns do exhibit important disruption at major turning points, just as they did last year (see marking on chart). But these two instruments do not show any degree of similar indication right now.
The conclusion would be that investors are not showing any increase of interest in alternatives to stocks, and for the moment, they stand ready to buy the dips in any upward trend.
The Bottom Line
Despite closing lower today, the Nasdaq 100 and the S&P 500 closed in the upper half of their trading ranges, signifying that some investors still want to be buyers. Neither bond price action nor the prices of precious metals show any indication that investors are ready to move money away from stocks and into these markets. This implies that a bear market is unlikely to begin right now.
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