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Need to Know: This signal is ‘raising a red flag’ for the stock market rally

Need to Know

The signal identified the market top in 2007 and the market bottom in 2009

A divergence between the S&P 500 and VIX indexes raises a ‘red flag’ for the stock market rally, former hedge-fund investor Jesse Felder warned.

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The VIX index is “raising a red flag” for the stock market rally, flashing a warning signal that predicted the 2007 market top, according to former hedge-fund investor Jesse Felder.

The author of the popular Felder Report financial blog said that typically the stock market and expected volatility — indicated by the VIX index — should move in opposite directions. Any divergence from this, which Felder said has now appeared, can signal “an impending reversal.”

The 2007 stock market top and the 2009 market bottom were both identified by a divergence between the S&P 500

index and the VIX, he said. “Since then we had several bearish non-confirmations that warned of significant corrections. Today, we have another bearish non-confirmation,” the Bear Stearns & Co alumnus said.

The S&P 500 index and inverted VIX index over the past 15 years

The 10-day correlation between the S&P 500 index and the VIX has risen into positive territory, which Felder said can serve as an effective short-term sell signal.

“Right now, this VIX warning signal is flashing again as it did earlier this year and prior to the corrections in the first and fourth quarter of 2018,” he said.

 “In short, the options market is sending a message that volatility going forward is likely to be greater than the stock market currently implies. And history shows the options market is usually the only [that] wins this sort of argument,” he added.

The chart

If this chart from Goldman Sachs is anything to go by, then the U.S. dollar bear market may have some way to run, Robeco portfolio manager Jeroen Blokland noted. He said there have only been three U.S. dollar bull markets and two bear markets since the 1970s.

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