Thursday, November 17, 2011

Neutral on Stocks, But Further Declines Will Increase Their Appeal

I recently turned neutral on stocks after their extraordinary strength in October.  While there are numerous factors that affect stocks and numerous--and often conflicting--indicators, a good (contrary) indicator of investor sentiment is the VIX Index of option volatility.

In trying to identify market tops, there is little information in a low VIX level (which indicates widespread investor optimism), as low readings can persist and stocks continue rising for an extended time.  

A high VIX reading, however, has been associated with market bottoms over the past fifteen years.  When the VIX has been above 28.5 (less than 20% of the time), the S & P 500 Index has returned 40% annualized.  It closed today at 34.5.  Persistence at this level on the VIX Index, or even higher levels, will increase my confidence that stocks have greater near-term appreciation potential.

Steve Lehman

S & P 500:  1216

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