Unusually Low Volatility Levels Mean You Should Move to Cash
With the Dow Jones Industrial Average at all-time highs and volatility, as measured by the VIX Volatility IndexI:VIX , near all-time lows, it's time to declare victory and move to cash or U.S. Treasuries, at least temporarily. Last week, the S&P 500 experienced multiple new highs, closing up almost 1.5% and above the May 2015 highs. The fact of the matter is that we've been in a trading range for two years and have only recently experienced a breakout. It won't be long until we're back in our ever-familiar trading range, unless you believe that euphoria lasts forever.
Going back to 1990, using end of day data, VIX only spends about 16% of the time below 13 and only 12% of the time below 12.5. Yesterday's close at 12.44 was one of those times. What are some other times where VIX closed around 12.5? The last time that VIX closed below 12.50 was August 10, 2015, when it closed at 12.23 and the S&P 500 closed at 2104.18. A little over two weeks later on August 25, the S&P 500 closed at 1867.61, for a drop of 11.24%. If you go back to May 21, when the VIX closed at 12.11, and the S&P hit its previous all-time high, once again, 11 days later the S&P closed down 2.42%.
I will admit, these days are cherry-picked. If you were to go back to 1990 and examine how the S&P 500 does five, ten and 15 days after the first close below 12.50, the S&P 500 is 0.06% lower, 0.00% and 0.21% higher, respectively. And if you were to invest in the U.S. 10 Year Treasury Bond, you would respectively make .08%, .09% and .01%, five, ten and 15 days later (IEF data only goes back to 2002). I wouldn't exactly get out of bed for these rates of return.
When we took out our May 21, 2015 previous high, then closed at our February 11, 2016 lows, many Elliott Wave practitioners believe that this defined the 4th wave and we are now in the 5th wave, which could indicate a fifth wave objective of 2467.26. How you reach that is objective is complicated and something to discuss later.
Essentially, we are still in our upward trend channel defined by our March 2009 and October 2011 lows and April 2010, April 2011 and February 2015 highs. Our recent breakout from the May 2015 highs suggests the will likely continue but watch for a pullback to the bottom of the upward sloping trend channel and back into our familiar trading range before we continue higher. Beware the Bull Trap.
This article is commentary by an independent contributor. At the time of publication, the author held IEF.