News was light on both sides of the pond yesterday, and investors took a
breather. It almost seemed like a holiday week with low volume and a lack of
market leadership. The biggest news was that Europe's banks continue to ship
money to the European Central Bank at a record pace, indicating that they have
little incentive to put the money to work by lending to other banks. And it's
no wonder the Europeans are fearful. Germany's economy contracted by 0.25% in
Q4, and Spain's industrial output fell 7% in November, following a decline of
4.2% in October. And an auction of German government five-year paper was gobbled
up despite a yield of under 1%. Our market closed mixed with the Dow Jones
Industrial Average off 13 points at 12,449, the S&P 500 was up fractionally at
1,292, and the Nasdaq gained 8 points to close at 2,711. NYSE volume totaled 758
million shares, and the Nasdaq traded 445 million. Advancers were ahead of
decliners by about 1.3-to-1 on both exchanges. Click to Enlarge In Tuesday's
Daily Market Outlook , we discussed the sentiment or contrarian indicators, one
of which was the CBOE Volatility Index (VIX). This is often referred to as the
"fear index" because it is based on a blend of various options on the S&P
500. Options prices tend to increase when more volatility is present and fall
when uncertainty is low. This fear gauge is mostly used to identify tops and
bottoms of markets. Click to Enlarge I published this chart a couple of weeks
ago in order to illustrate the influence of headline news on the S&P 500 in
2011. Notice the direct correlation to the big swings in the S&P 500 and the
swings in the VIX. The spring of 2011 was quiet until the Bank of England
announced an inflation rate of 4%, and the Greece debt rating was cut to B1
followed by the Japanese earthquakes and tsunami. But the real kicker hit when
the U.S. rating was cut to AA+, and the VIX rocketed to the high of the year at
48 on Aug. 8, followed by the "out of box" error that drove the VIX up
again. From Aug. 8 until the end of the year, investors were pummeled with one
headline after another, and both the chart of the S&P 500 and the VIX illustrate
the enormous swings. The VIX has been criticized as having little predictive
value. But it is useful in determining oversold and overbought market
conditions. Note the relative complacency of the S&P 500 from April to late June
when the VIX traded as low as 15 just before the June rally and then the market
sell-off. The high readings over 40 told us that the market was deeply oversold
but that we should expect extreme volatility. And the last five months of the
year turned out to be some of the most volatile on record with price swings
directly tied to the latest European headlines. Now, with the VIX back in the
"complacency" zone, stocks have turned positive. The VIX is telling us that
the recent breakouts are genuine but that the market will probably trade in a
narrow zone much like the beginning of 2011. Nothing, however, can forecast the
impact of bad headline news, and when that occurs, the VIX and every other
indicator lose their predictive value and become followers. Click to Enlarge
After lagging the other indices, the small-cap Russell 2000 finally broke
through its 200-day moving average. This confirms that the intermediate trend of
the broad market has turned. But with such low volume, stocks could trade in a
relatively narrow range for several months. If that happens, your best bet may
be to trade options. And if you're looking for help making profitable trades,
you may want to check out my colleague Joe Burns . Todays Trading Landscape To
see a list of the companies reporting earnings today, click here . For a list of
this weeks economic reports due out, click here .
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