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Saturday, 23 October 2010

If Stocks Are Near 2010 Highs, So Is Complacency

by Nick Godt

It's not just the stock market that's revisiting levels unseen since April: The Chicago Board of Options Exchange Volatility Index, which gives the pulse of the market, is trading near its lowest levels since the spring.

Last week, the VIX otherwise known as the market's fear gauge, sank below 20 for the first time since May 3 and it closed below 20 for the first time since April 29.

When the VIX drops below 20, it typically signals complacency is rampant in the stock market. Bad news is brushed aside, and stocks react to any news that's not "as bad as feared" with a rally.

But the market can only see the glass as half full for so long. Eventually, the cup overfloweth.

We're not there yet. The VIX sank to its lowest level for the year, near 15, in April as stocks continued to cheer the belief, back then, that the global economic recovery was for real, until a crisis in Europe forced a correction and a reassessment of reality.

But it's worth noting that the stock market's violent reaction Tuesday to China's surprise rate hike — which saw the VIX jump 8% as the Dow industrials tumbled 165 points — could be a signal of things to come.

Of course, stocks bounced back on Wednesday as the VIX fell back below 20. We are in earnings season and, much more importantly, the market is now assured that the Federal Reserve will soon provide more liquidity to try to offset a slumping economy and deflationary pressures.

After all, stocks' rebound since July has come in the face of mounting evidence that the economy is slowing, making it more and more likely that the Fed will delivery another round of its so-called quantitative easing measures.

The central bank won't meet until early November. That gives plenty of time for the VIX to continue to fall. And it might be just when the liquidity is delivered that the cup will overflow

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