Mid-week market update: Even though I remain constructive on the intermediate term market outlook, short-term risks are rising. The VIX Index fell below its lower Bollinger Band on Monday, which is an indication of an overbought market. In addition, the index is flashing a negative divergence on its 5-day RSI.
Here is the historical study of what happens when the VIX falls below its lower BB. Returns are subpar and bottom out about four days after the signal. If you wait until the signal recycles, or the VIX to rise back above its lower BB, returns are immediately negative, and the market falls and flattens out for 4-5 days.
As well, short-term market based sentiment look very complacent. Four of the five sentiment indicators that I monitor are in the high risk zone: the absolute level of the VIX, VIX term structure, VIX BB width, and the 10 day moving average of the equity-only put/call ratio. Only the the 10 dma of the TRIN is not reflecting excessive buying.
Sentiment signals, by themselves, do not constitute actionable sell signals. However, the combination of widespread complacency with active triggers such as a negative RSI divergence, or the VIX falling below its lower BB represent a short-term warning flag that the market advance is likely to stall.
SentimenTrader tweeted a similar sentiment warning today.
Subscribers received an email on Tuesday morning that my inner trader had initiated a small short position. As the day after US Thanksgiving has historically been bullish, he expects to add to his short on Friday, should prices advance.
My inner investor remains bullishly positioned. Remember that this is only a tactical warning, and any pullback should be shallow. The intermediate term path of least resistance for stock prices is still upwards.
Disclosure: Long SPXU