Saturday, January 28, 2017

Market Breaks Out Of Sideways Trading Range To The Upside

Over the course of the last three trading days this week, the S&P 500 Index and Nasdaq broke out of the trading range in place since mid December. We highlighted this range in a recent post that noted sizable corrections are unlikely when earnings are improving.

For most of the period since the beginning of the second quarter last year, new highs have exceeded new lows, indicating the broader strength of this advance.

Not participating in the break out are small cap stocks; however, the 50 day moving average continues to hold support.

The fact this is the second longest rally since the end of 1932, it does seem a market pullback is due. Investor complacency seems to have set in with the VIX trading near single digits. But...

....with the VIX trading at a low level, one should evaluate the VIX in relation to the 10-year Treasury yield. This sentiment measure evaluates investor risk appetite and the market's view of economic growth. A low level of the denominator of this ratio, the 10-year Treasury yield, is indicative of a slow growth economic environment and investors' propensity for risk off assets; hence, pushing the yield lower. If the numerator, the VIX, is elevated, this is an indication of investors' fear of the equity markets. What is taking place at the moment is just the opposite, i.e., a low VIX indicating investors propensity to invest in riskier assets. The 10-year Treasury yield is trending higher and indicating investor expectations for a faster pace of economic growth. The 10-year Treasury yield has climbed from 1.37% in early July last year to 2.48% as of Friday's close.

As can be seen in the first half of the above chart, the VIX to 10-year ratio can trend at a low or even lower level for an extended period of time while at the same time equities continue to move higher. So a pullback in equities might seem warranted at the moment, but investors actions do not seem to be confirming this.

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