What is up with this market? Unfortunately this is the effect of both year-end profit taking at 15% long term capital gains rates while you still have them and more economic uncertainty as we approach the upcoming “fiscal cliff.” The good news is that I think we’re approaching a bottom in the near future (assuming congress does something, which I’m aware of how dangerous that is to assume). If we continue to fall to the 1300-1330 range on the S&P 500 though, I’ll be a big buyer of stocks as I’m still expecting a spring rally.
The tricky part about this market though is that some major components (like the transportation stocks) are breaking down and signaling a fairly deep correction. This gives me caution. On the other hand, the Volatility Index (VIX) and high yield bonds are disagreeing. The VIX is still at 17% – and has actually been falling the past few days! If we were breaking down and beginning a deep correction, you would see the VIX well above 20%.
I think the main cause of this sell-off is profit taking in the stocks that have been the best performers. We’ve seen a very nice correction is the high dividend (high yield) paying stocks. Over the past two years, high dividend payers have traded more like bonds, rallying in price and driving down the yield of their dividend payments. Now that rates are set to increase on qualified dividends, many people are taking gains and swapping into municipal bonds. Just take a look at municipal bonds since President Obama was reelected. As the yield premium (yield over Treasuries) of high dividend stocks continues to widen, I expect the effects of Fed easing to kick in and push these stocks higher again.
S&P 500 – 1 year
VIX – 1 year
Muni Bonds – 6 months
We’ll see where things go from here…
Nick