Short-term Outlook:  25% Bearish  As of Jan 12, 1134 SPX

Equity Indicators - Updates and Extremes

Rydex Bull / Bear Ratio

Over the past few months, we've looked at Rydex traders several times, noting how their behavior has changed since July.

Since then, they have on multiple occasions switched heavily into the bullish index funds while fleeing the bearish inverse funds, in attempts to "buy the dip" on small pullbacks in equities.  Almost without fail, the S&P 500 had at least another -1% down day in store not long after, and scared these traders out of their positions.

After yesterday's dip in equities, once again Rydex traders are going back to the well.  And they're doing it in style this time, with the largest skew towards bullish funds in seven years.

Combined with the surge in speculative options activity and the dearth of volume in the inverse ETF funds that we've discussed the past two days, this continued mentality of every dip being an automatic buying opportunity seems just too pat to last.

VIX

I've been asked more than a few times about a sell signal given by the VIX yesterday.  This has become popular fodder recently, apparently due to a mention from Art Cashin at UBS in a note to clients (the signal is from Robert McHugh of Main Line Investors).

A sell signal for equities occurs when the VIX drops below its lower Bollinger Band (2 standard deviations from the 20-day moving average), then closes back above.  Basically, what we're seeing are times when volatility drops to an extremely low level (relative to the past month), then pops back up.  Ostensibly, that's a negative sign for equities going forward.

Let's check out the efficacy of those signals since 1990:

 

S&P 500 Performance After VIX "Sell Signals"
	1 Day Later	1 Week Later	2 Weeks Later	1 Month Later	3 Months Later
Avg Return	-0.4%	-0.4%	0.0%	+0.5%	+1.9%
% Positive	37%	47%	55%	57%	67%

The S&P was weak in the very short-term after these signals, but that's about it.  After a couple of weeks, the S&P's returns were in line with random.

But let's add a little wrinkle and stipulate that not only must the VIX drop below its lower band, but also hit a 52-week low at the same time.

 

S&P 500 Performance After VIX "Sell Signals" When VIX Hit A 52-Week Low
	1 Day Later	1 Week Later	2 Weeks Later	1 Month Later	3 Months Later
Avg Return	-0.3%	-0.8%	-1.2%	-1.0%	+0.1%
% Positive	55%	45%	36%	27%	45%

Over the next month, there were only 3 winners out of 11 trades, and two of those winners were tiny, less than +0.2% (the other one was +2.1%).  Over those month-long trades, the S&P moved down an average of -3.0% at its worst, and up an average of +1.4% at its best, so meaningfully skewed to the downside.  This is another measure arguing for a multi-week correction in equities.