It’s beginning to look a lot like August…
And that’s a problem for the rest of the year.
The stock market rally that started in mid-June and lasted until mid-August was powerful.
It boosted the S&P 500 by 600 points and got most of the financial world talking about the start of a new bull market.
But by that time, most of the technical indicators we follow were in extremely overbought territory…
On August 1, the long-term monthly chart of the S&P 500 was banging into resistance. On August 8, the Bullish Percent Index for the S&P 500 (BPSPX) was on the verge of a sell signal. And by August 15, VIX option prices were screaming at investors to be careful.
Now, fast forward to today…
The stock market has enjoyed a strong, two-month-long rally. The S&P 500 is up more than 500 points from its early October low.
Just about all the financial TV talking heads are bullish again and talking about a new bull market.
But once again, most of the technical indicators we follow are in extremely overbought territory. They’re warning the market is vulnerable to a decline.
For example, the BPSPX generated a sell signal last week. And now the financial sector is lagging behind the broad stock market.
VIX option prices are predicting a much higher VIX in the weeks to come – and a higher VIX usually goes along with a falling stock market.
Perhaps most concerning, though, is the VIX just generated its third sell signal in the past six weeks.
Take a look at this VIX chart…
The VIX generates a broad stock market sell signal when it closes below its lower Bollinger Band and then closes back inside the bands.
Unlike VIX buy signals (which often play out right away), VIX sell signals often take several days (or even weeks) to kick into gear.
Sometimes, it takes the VIX generating a cluster of sell signals before we get a significant move lower in the stock market.
But eventually, we get the sell-off.
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To see what I mean, take a look at the cluster of sell signals that occurred in July and August. It took three sell signals to finally put an end to the stock market’s summertime rally.
Within seven weeks, the S&P 500 lost 700 points following that third signal.
Now, over the past six weeks, the VIX has generated three broad stock market sell signals. The third one triggered last Friday (right arrow).
If this cluster of sell signals plays out like the cluster we saw in the summer, then stocks will soon head lower.
Traders should be careful in the weeks ahead…
Most of the TV talking heads are looking forward to a Santa Claus rally. But the VIX is warning us that Santa may not show up this year.
Best regards and good trading,
Jeff Clark
Reader Mailbag
What are your stock market expectations for December?
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