Canary or Canard?

Earlier in the week, I introduced a ratio chart of the percentage of S&P500 stocks above their 50 day SMA divided by the VIX. I described this as an attempt to find a rough approximation of greed ÷ fear. Since this chart received some favorable reviews, let me unveil another VIX ratio chart that attempts identify the same market sentiment extremes and provide a warning about the increased probability of near-term market highs and lows.

The chart below is a weekly chart of the ratio of the new 52 week highs in the NYSE divided by the VIX. I focus primarily on the raw number and the 4 week SMA. You can see from the chart that raw reading above 30 and a 4 week SMA readings above 20 tend to signal that a top is near.

In fact, this chart provided excellent advance notice of the 2/27/07 top, the 5/11/06 top, and previous tops in March 2004 and March 2005. With bottoms, the record is not quite as good, with an excellent advance call of the October 2005 low, but calls that were too early for May-July 2006, March-August 2004, and July 2002-March 2003.

You can decide if this ratio chart deserves a spot in your toolbox or bird cage or whatever it is that you use to try to divine the future. For me, it’s a keeper.

Are We Done Yet?

The answer, of course, is that nobody knows. For the most part, panic and fear are not fleeting emotions.

For the curious, the photo on the left is of Colca Canyon, located in southern Peru. The canyon is twice as deep as its more famous relative, the Grand Canyon. What I find particularly interesting about Colca Canyon is that despite a vertical drop of over 10,000 feet, much of the canyon is terraced and relatively flat.

In thinking about the current investment topography, one of the more obscure charts that I refer to from time to time is a ratio chart of the percentage of S&P500 stocks above their 50 day SMA divided by the VIX. It is a rough approximation of greed ÷ fear and prints some interesting extreme numbers from time to time, particularly for market bottoms. Because the values of this ratio chart are one ratio divided by another, it is possible to compare values over time and get meaningful results.

In looking at the weekly ratio chart below, one of the first things that jumps out is the toppy readings (6.0 – 8.0) that persisted over the past six months or so, as compared to the previous high readings, which tended to last only a month or two.

The downside spikes are even more pronounced and tend to be much more short-lived. We know that the moves in the VIX over the past week have been unprecedented, but what the chart indicates is that given the steepness of the decline and the current low reading of 1.55, the ratio is not likely to deteriorate much further, if at all. Don’t expect the ratio to stay in the Colca Canyon area – or even below 3 – for much longer.

I am certainly not going to declare that this ‘correction’ is over, but I will go out on a limb to say that the worst of it is likely behind us and that further declines, if any, should be a lot more orderly.