The Problem With This Rally

Earlier this month, the Volatility Index (VIX) generated a broad stock market buy signal.

Previous buy signals had paid off quite well for readers who took advantage of them. But, I suggested folks would be better off passing on this one.

The stock market had already used up a lot of energy just triggering the buy signal in the first place. There wasn’t much fuel left to help push stock prices even higher.

In fact, some of our indicators were closer to being overbought than they were to being oversold.

The S&P 500 was trading near 4135 two weeks ago when we got the VIX buy signal. On Friday, the index closed at 4192. That’s a 57-point gain, or roughly 1.4%, which is a respectable return for two weeks.

Some readers might argue we should have played the buy signal after all.

Sometimes, though, it’s more important to focus on risk than on reward. And, for me at least, this was one of those times.

There are a lot of problems with the current rally – starting with the lack of participation.

More stocks have declined over the past two weeks than have advanced. The rally is being led by just a small number of high-flying tech names – like AAPL, MSFT, and NVDA – while most other stocks are marking time, or losing ground.

That sort of “bad breadth” is often a caution sign.

High yield bonds are also not participating in the rally.

As we noted last week, the action in junk bonds often leads the action in the stock market by anywhere from two days to two weeks. Junk bonds are trading lower today than where they were two weeks ago.

So, that’s another cause for concern.

Finally, there just aren’t all that many bullish looking trade setups. I look at a few hundred charts every day. And, I’ve been struggling to find much of anything that reads bullish.

There aren’t a lot of overly bearish setups either. But, I wouldn’t expect that while we’re working on a VIX buy signal.

The lack of bullish setups is just another indication that the current buy signal just doesn’t have a lot of upside potential.

As a trader, it’s normal to want to take advantage of every signal our indicators generate – especially indicators as reliable as the VIX. There are times, though, when the potential reward of a trade simply doesn’t justify taking the risk.

Yes, the market is higher today than where it was when the VIX generated its recent buy signal.

But weighing the risks versus the rewards, it’s still not a trade I would take.

Best regards and good trading,

Jeff Clark

How do you feel about this current rally?

Let us know your thoughts – and any questions you have – at [email protected].