Friday, February 17, 2012

Complacency! What Complacency?

I just want to bring your attention to something that is developing in the realm of 'complacency'.  The chart below measures the price of the S&P 500 in terms of the $VIX.  It answers the question "how expensive is the S&P if we had to pay $VIX units to buy it"?  By historical standards, at the current price of 75.83 VIX units the S&P it isn't expensive at all.  Why back at the April 2011 peak, one unit of the S&P cost 93.25 VIX units.  So when we compare the two, with the S&P now back to basically the same level as it was at the April peak, it is now 23% cheaper in terms of VIX units.

Click here for a live and updated version

But not so fast there Newt... this isn't necessarily anything particularly positive.  To the contrary!  Let's put this into proper perspective.  At the instant before the market crashed back in April investors were pretty darned nervous that equities might be dropping soon.  They were right.  Today, with the S&P back to the same level, it could be said that investors are now 23% less
concerned about the possibility of any pullback in equities.  Of course, that simply means they've never heard of Greece.  Apparently they are also unaware that there is an entire continent full of Greeces to the east of us called Europe.  No worries.

From the technical perspective an entirely different story is unfolding.  An identical type of phenomenon is now developing in the relationship as that which existed just prior to the 2007 peak in the stock markets.  And of course I'm referring to the negative divergences.  Now as all of us know, a negative divergence does not in any way indicate when a top might be in.  It only gives a hint that a form of momentum is being lost... quietly.  It provide a 'wink-wink' to sit up straight and get on the alert for more pertinent signals.

I'm not at all concerned about the 'actual price' level in this ratio as much as with the increasing complacency that is accompanying it, complacency which is not overly obvious on the surface.  The degree of "comfort with the long side" should not be increasing like this, at a time when the market a) stretches with all its might to hit a very key price level and b) it does so in the face of the most extraordinary and historic period of danger the world has ever been exposed to.  In a nutshell, the metric we are looking at is pure lunacy.  That doesn't necessarily mean that the lunacy can't continue but it does suggest the lunatics are very possibly going to find out what fear really is once we get an appropriate signal.

And lo and behold... a signal such as that which has just developed in the MACD histogram as well as in the stochastics.  At the current moment, they are in an identical condition as they were at the 2007 peak.  This does not necessarily mean the market is for sure going to crash at any moment, but only that "by golly it sure is on thin ice". Caution is warranted to say the least.