Have We Hit Bottom Yet?

I’m back from an extended (and much needed) Easter break and even though the hiatus only lasted for four days, I feel as though I’ve been absent for weeks. “Rusty” is the word that applies here. So, to ease myself back into the blogging mind-set, I’ve decided to do a brief market commentary today as opposed to my usual full-blown discourse on something that requires an inordinate amount of brain power.

When I don’t have an actual subject in mind, I usually am able to find one simply by perusing the stock charts. What really stood out today is not any one stock in particular, but rather the overall market action–the VIX in particular. You’ve probably heard the term bandied about by the CNBC talking heads, but do you know what it is and what it means? Chances are, most people don’t and I think they should.

So, what exactly is the VIX? The VIX is the CBOE market volatility index and is viewed as a measure of market uncertainty or market risk. The index is constructed from the implied volatilities of S&P 500 index options, both calls and puts. (The implied volatility is a result of the Black-Scholes options pricing formula and is beyond the scope of this discussion.) The VIX is viewed as a leading indicator reflecting investors’ expectations of future market uncertainty. Values greater than 30 correspond to highly uncertain markets (like now) while values below 20 correspond to less stressful or even complacent markets. For example, the VIX was range-bound between 10 and 20 during the recent bull market starting in 2003. The VIX finally shot above 20 last July which should have alerted investors that the market was running out of steam.

What is the VIX telling us now? Since last July, it’s been forming a triangle pattern, making a series of higher lows that bounce off the 200 day moving average (if viewed on a daily chart). VIX tops correspond to market lows and vice versa. During times of market instability, the VIX provides an inverse mirror to overall market movement. It has already made three bounces off its 200dma. Oddly (or not so oddly), these bounces have also occurred at its Fibonacci retracement levels. The next and last Fibonnaci level is at the 25.50 level which is where the VIX is hovering about today. If it breaks through this level to the downside and especially if it manages to break its 200dma at around 23, then I’d say the probability that the market will enter a bull phase is excellent. Just to be sure, I wouldn’t back up the truck until the VIX clears the 20 mark.

Enough about the VIX and Fibonacci voodoo. Is there anything else that the market is telling us? Yep. Today, the Dow Transports (DTX)–a leading market indicator–just cleared minor resistance at 482. If it can break through major resistance at the 492-500 level, then things will really be looking rosy. The other major market indices are also nearing resistance levels on heavier than average volume, so we’ll keep an eye on them, too.

Okay, if the market is indeed staging a turnaround, what should investors be putting on their shopping lists? In general, the leaders in previous markets tend to be laggards in the next. For example, commodities have enjoyed a huge run-up and although I do think they might have more upside, they’re beginning to look a little tired. Witness the 10% fall in gold in just the last week! The sectors that are starting to show signs of life are the following:

REITs — real-estate investment trusts which I featured last week
Retail stocks — Urban Outfitters (URBN), Nike (NKE), and Wal-Mart (WMT) are all posting new highs today
Railroad stocks— CSX and Genesse (GWR) are at new highs
Computer Architecture–the computer architecture ETF, the IAH, took a nice jump today almost clearing resistance; stocks in this sector that are looking particularly attractive are Ciena (CIEN), IBM, Cisco (CSCO), Apple (AAPL), and Hewlett-Packard (HPQ).

What about financials? Many of them have started to turn around, but I wouldn’t be a buyer yet. I think we’ve got more unwinding to do in the credit market first.

Well, that does it for today. Tomorrow I’m hoping to discuss the exciting and profitable field of emerging markets. Stay tuned!

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