Watching Volatility (VIX) as an Indication of Market Momentum

The market is obviously stuck in a tight range and is looking to breakout to one side or the other. So which side is it going to be? There are several indications that the market may be headed toward new lows before the summer is over. What seems to be capping any attempt at a rally are a few factors. These include a war in Iraq, a Middle Eastern conflict between the Hezbollah and Israel, sustaining high energy prices, a slowing economy and a Federal Reserve that is complacent with tip-toeing around their true intentions regarding interest rates.

One of the market indicators that I have noticed a slight shift not only in momentum, but in the trend as of late is the CBOE’s volatility index (VIX), which is generally known as the market’s fear indicator. Generally, as the market moves higher VIX remains low and complacent, but as the market gains uncertainty and sells off, VIX spikes to levels that match the market’s fear of uncertainty.
The chart below presents a visual of this relationship. I have overlaid the VIX (statistical in blue, implied in red) on top of the S&P 500. As the market tumbled during May and June, VIX ran to multi-year highs; reflecting a strong fear for a weak market. During my analysis, VIX has broken out of its tight trading range and is trending ever so slightly higher as the market remains complacent within its current trading range of 1230-1288. In fact, the S&P 500 futures are currently trading at 1274, while one month ago the futures were trading near 1278. Consolidation in the markets typically means that something is looming over the market. Whether the market is digesting the recent event
click on the chart to enlarge

or if the market is getting ready for a large move is an unknown; however, we do believe that something will happen sooner than later, but the tight trading range may continue through the rest of the summer.
If VIX is an indication of leading the market in one direction or another, the market may be in for a bumpy ride this August. August is historically one of the worst performing months in the history of the stock market and according to the current trend, it could continue to feed into that historical weakness.
Not only is the VIX pressuring the market, but daily trading has become rather frail as well. At every attempt of a rally, the market seems to sell into each rally. Not only do these attempts show weakness, but the bears have been in control and at each rally; sellers come in and tame the market quickly. I am only suggesting that the market has an easier ride downward than upward. The work facing the bulls is just too much, but then again, markets shift direction exactly when everyone has decided that it can’t go in that direction. I will continue watching VIX as well as any sign of momentum shift in the markets. In fact, this week should help the market make up its mind on whether or not the Federal Reserve will hike rates above 5.50% in the face of a slowing economy and strong inflation as the PPI, and CPI are both due out over the next few days.

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