Bad News, A Bullish Wall of Worry and Sell Signals

A VIX below 20 does not build a wall of worry.

Investors have become used to seeing the market climb despite an annoyingly persistent backdrop of bad news.

I wrote about this phenomenon in mid-February and philosophized that anything that’s too obvious is obviously wrong. Bad news or not, investors saw no possible reason for stocks to decline. In fact, higher stock prices were expected because:

  • The Fed won’t allow prices to drop. As long as there’s QE2 (or QE3, QE4, etc) prices will go up.
  • January was positive. As January goes, so goes the year.
  • 2011 is the third year of the presidential-election-year cycle. The third year hasn’t seen a loss since 1939
  • There’s simply no catalyst to send stocks lower
  • Wall Street analysts are one-upping each other on positive forecasts.

In mid-February the CBOE Volatility Index (VIX) appropriately dropped to 14.86, a 3 ½ year low, which would explain the persuasive complacency.

The audacity to point out that a VIX at around 15 has caused major reactions in October 2007 and as recent as April 2010 earned me much mockery. My the ETF Profit Strategy Newsletter I recommended to unload long positions at VIX 15 more than just once. That’s been a good idea nearly all the time.

Throughout the post-2009 rally there’s been a constant supply of bad news. As any major rally, this two-year monster rally sprouted out of the fertile soil of excessive pessimism.

At the March 2009 lows a majority of investors had thrown in the towel and wanted nothing to do with. This was a clear sign for the ETF Profit Strategy Newsletter to issue a strong buy alert.

The initial stages of the rally were considered “green shots.”

As the rally continued, defying all conventional wisdom, big problems, like unemployment, were downplayed and the recovery termed a “jobless recovery.”

The issue of housing prices, which just dropped to a multi-year year, was largely ignored. How can banks recover if their toxic mortgage portfolios don’t?

If these problems would constitute a bullish “wall of worry” investors would have resisted rising prices.

To the contrary though, investor sentiment has been off the charts for much of 2010 and 2011. A VIX below 20 does not build a wall of worry.

Of course some will argue that retail investors just starting pouring back into equities at the beginning of 2011.

This is correct and could mean further gains. But it could also mark a turning point, just as their mass exodus in early 2009 did.

However you slice you, we live in unique times.

By many measures the market has defied history and played games with investors emotions. The ETF Profit Strategy Newsletter tracks the forces that move the market in an attempt to stay on the right side of the trade.

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