Stocks Looking Shaky Again

This morning the European Central Bank announced they’ll be joining the fun and adding their own Quantitative Easing.  The Euro currency, which had already been falling since early May, cratered on the news.  This should be “good news” for stocks.  European stocks rallied on the announcement and the US market seemed poised for a positive day as well.  However, we failed to hold the gains today.  It’s not a good sign when a stock (or market) fails to rally on good news.

There are two big divergences jumping out at me right now as red flags for the stock market in the near future.  The first is the Volatility Index (the VIX), which basically measures investor sentiment over the next 30 days.  The VIX rises when investors are fearful of a drop in stocks and are buying out-of-the-money put options as protection.  You’ll typically see a divergence between the VIX and the stock market before a fairly decent-sized pullback.  A divergence is when the VIX makes a higher low while stocks make a higher high – it says that investors aren’t trusting these new stock market highs as much as they were back in July.

S&P 500 (top) vs. VIX (bottom) – 6 months

There’s also a similar divergence between stocks and high yield bonds. I noted in a prior post that this divergence appeared in July as well, signaling the drop in early August.

S&P 500 (top) vs. High Yield Bonds (bottom) – 6 months

Many stocks are still finding strong support on the dips which leads me to believe the market can still push higher, but these red flags could be signaling a better buying opportunity in the coming weeks.

-Nick