Hey There Income Hunter,
Thursday’s actions may have been triggered by Meta Inc. (Ticker: FB) earnings … but if we were still in a bull market investors would have shaken it off and bought the dip.
But this, friend, is not a bull market.
Every day we are getting more entrenched into a nasty Stage 4 bear market. (I covered the market market stages yesterday.)
There was only one sector up on the day – consumer staples (XLP). That is the top sector to buy in a bear market, along with utilities and healthcare.
The one anomaly is oil, and that will torture the Federal Reserve by keeping inflation higher for longer.
These next few months will be a nightmare for the Fed if growth continues to slow and the market continues the trend lower.
Today, I want to take you through the four major indicators of risk in the markets. Three of the four are flashing red and the last one is close.
When all four are screaming “bear!” look out below.
The 4 Signposts of Market Risk
The Vol of Vol Spread
The vol of vol spread is simply the ratio of the VIX volatility (VVIX) divided by the volatility of the S&P 500 (VIX).
This ratio confirms a breakout to the upside in the VIX. It works the same as the volatility for any instrument.
As you can see in the chart below, the VIX has broken out higher from it’s lower trading range as the volatility of the “fear index” has broken down.
So, the VVIX/VIX ratio is bearish.
On to the number 2.
High Beta/Low Beta Ratio
The high beta/low beta ratio is the second risk measure, and it broke down in Q2 ‘21.
In bear markets you want to stay with low beta stocks that will lag behind the indexes and, obviously, stocks with high beta relative to them.
For this ratio I use the Invesco S&P 500 High Beta ETF (Ticker: SPHB) and the Invesco S&P 500 Low Volatility ETF (Ticker: SPLV).
As you can see below, this spread broke down in Q2 2021.
The Small Cap/Mega Cap Ratio
The third market risk measure is the small cap/mega cap ratio and this spread broke down around the same time as the high beta/low beta spread above.
Value/Growth Ratio
The last holdout, but one that is on the cusp, is the value/growth ratio.
Here I use the Vanguard Value ETF (Ticker: VTV) and the Vanguard Growth ETF (VUG).
The spread is getting close to a breakout to the upside, led by value.
The breakout confirms selling lower prices if needed because the market is moving into a deep Stage 4 bear market.
Also of note, the iShares Investmentment Grade ETF (Ticker: LQD) got crushed on Thursday.
This is very meaningful because it signals possible credit issues are brewing for BBB corporate bonds.
BBB bonds are the most widely held bonds in LQD, and if this continues we could see a serious meltdown in LQD.
Bring It Home
As I said earlier, this will get very interesting as we move towards the next FOMC meeting in March.
The Fed will announce its plans for quantitative tightening (QT) at that meeting. (This is when they sell bonds into the market to drain liquidity and reduce their balance sheet.)
There is no way the market can handle that, especially if we continue to trade lower and trigger real end user selling.
I will be watching that closely. Stay tuned here for the details.
Live and Trade With Passion My Friend,
Griff