Whenever a market hasn't corrected an advance for quite a while, either on a daily or weekly basis, and VIX/VXO are low, smart people get nervous. The market is then susceptible to a sharp decline due to technical deterioration, fundamental deteroration, or news, and that's what happened last week on China, Greespan, and US"subprime" mortgage news.
I wish I had paid greater attention to "sentiment divergence" which I have written about before. Both the 2CS of bearish sentinment and the one day sentiment oscillator became somewhat bearish between February 5 and February 23. It's always a tough call whether the divergence implies a near term decline is looming or it just represents persistently wrong-headed bearishness. But I have put up a new phrase on my monitor's frame along side Gilda Radner's "It's always something." The new one reads: "Sentiment divergence happens!"
Most US domestic stock mutual funds were down 4-5% and US mutuals holding non US stocks were down 5-7%. My total low volatility portfolio was down just 0.93%, so the program is working. I hasten to add that the low volatility approach of necessity also reduces gains in rising markets.
The week ended with the 2CS over 108 and with the one day sentiment oscillator having put in two days with readings under 4! These indications mean we should have a decent rally this week. After such a startling decline it is almost routine to retest the lows since the bears have more money and confidence and wish to press their luck further. Also some bulls who missed the exit signs will look to get out.
Technical indicators I follow remain bullish, so I feel we will see new market highs in six weeks or maybe far less time. Increased market volatility works both ways. I remember when people were predicting an imminent crash in 1996 to end the bull market as volatility rose above VIX 15. Primary tops of long bull markets do not end with VIX under 10, but minor or secondary tops may.
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