Today’s sharp rally in stocks and collapse in the VIX to an 8-1/2 year low of 12.60 shot the S&P500/VIX ratio skyward to retest its all time high of 87, the same level reached in August 2000 when the S&P 500 rallied to retest its March 2000 highs before collapsing.

More interestingly, the ratio between bond prices and the VIX, which is a pretty good gauge investor nirvana*, is also testing record highs.

Our simple analysis shows concurrent highs and lows in both bonds and stocks relative to the VIX, with a relative base for stocks around 20 and peak in bond prices around 8.

What this chart reveals is instructive – Sell stocks when both ratios are at a concurrent high (nirvana), and buy stocks when both ratios are at a concurrent low (fear).

Our first two sell signals (Nov 1993 and Oct 1995) occurred at the beginning of a bull market and would hardly have been worth the trouble.

But the subsequent two sell signals (Jan 1998 and Aug 2000) could not have been more beneficial to investors. Likewise, each buy signal (March 1994, Sept 1998 and Oct 2002) has been a roaring success.

Now consider that today both ratios are testing record highs together for the first time.

We must conclude from this simple analysis that investors are more convinced than at any time in the past 15 year that the economy is strong and inflation in check. As such, future evidence pointing to stagflation would be the single worst outcome for the US markets.

© 2004 Jes Black
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