Calm Before a Storm?

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Global stock markets have been enjoying a remarkable summer rally since June, remarkable for several reasons.

For one thing, the rally has been much more substantial than typical summer rallies, which are usually brief time-wise, and average about a 5% gain by the S&P 500.

This time, after topping out in March and declining 10% to its early June low, the rally is now in its third month, and the S&P 500 has gained 10% since the June low, putting it back up to exactly where it was when it topped out in March.

The rally has also been remarkable in its ability to ignore worsening conditions that normally spook markets; accelerating global economic slowdowns, declining earnings, and warnings from major corporations, to say nothing of a few additional unique concerns like the euro-zone debt crisis, and serious political dilemmas like the pending fiscal cliff in the U.S.

Another noteworthy difference has been the very low trading volume on which the rally has been floated higher. August is noted for low volume as investors, including the heads of large institutional investment firms, focus on getting in the last vacation weeks of the summer before children return to school and college.

But so far, this month has been very unusual in that regard, with trading volume on the NYSE running more than 30% lower than last August, and on track to be the lowest volume month since December, 2007.

Yet another noteworthy condition is that in spite of the surrounding conditions that usually spook investors and markets, investors are remarkably bullish, confident, and optimistic.

That can be seen most clearly in the VIX Index, also known as the Fear Index.

vix and s&p 500

It was at just 13.6 on Wednesday, its lowest level of fear (highest level of bullishness) in the last five years, lower even than at any of the rally or market tops since 2007.

Could it be the calm before a storm?

The reason I ask is that in addition to the VIX Index being at low levels of fear that have marked all the tops since 2007, as noted the last time trading volume was this low was in December, 2007. And that low volume rally ended mid-month and the Dow lost 1,600 points, or 12%, over the following 6 weeks, while the Nasdaq lost 20% over the following 10 weeks.

Something to think about, given that we are also in what has historically tended to be the most troublesome three-month period of the year. August is often a reversal month. September tends to be a negative month. And October most often sees a low and upside reversal.

There is even a very overbought condition above 50-day moving averages.

50 day moving average

But maybe it’s different this time. So many seem to think so.

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About Sy Harding

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