1/ The Stop-Go Method
2/ The 50% VIX Solution
3/ Momentum Precedes Price
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1/
The Stop-Go Method
Some investors believe that the recent 10% pull back on the S&P 500 baked-in all the bad news for 2025, and that from here we should comfortably rise. To these investors it looks like a great time to be a buyer. But perhaps a bit of caution is in order, at least until Friday’s Personal Consumption Expenditures (PCE) inflation number is printed.
In 2013 I co-authored a book with Toni Turner in which we published our research that included a unique method of measuring the relative strength of the S&P 500 (SPX) with the Utility sector as tracked by the State Street SPDR Utility sector ETF (XLU).
This was intended to be a simple indicator of the coming of a bear market. It is not a frequent signal, making only 5 to 7 appearances per decade, however, this signal often coincided with a continuing downtrend that would last two to twelve months. At the time we published the book, the signal had a track record of accurately preceding such drawdowns 90% of the time over an 85-year period. The curious need wait no longer to review its current state (see below).
The signal has not yet fully formed. The bear signal needs to show both an outperformance of XLU over SPX and a consecutive increase of the average true range (ATR) for a two-month period. The current chart certainly shows XLU outperforming SPX for two months straight, but the ATR needs to see another month of volatility increase before declaring that a bear market will follow. That indication could be final as early as April 15th (half way through the second month).
This bears watching because it means the market is potentially at a critical inflection point. If price volatility continues to increase over the next two to three weeks, it will translate into a warning signal that 2025 still has more downside to come.
2/
The 50% VIX Solution
A shorter-term outlook gives investors a bit of hope however. The Volatility Index (VIX), a measure of option price behavior, has completed more than a 50% pullback from its recent peak. Historically this is a bullish indication for the coming one to three months (see chart).
However this 50% retracement rule that I use is typically effective on quick spikes that shock the market and scare investors away for a bit. The most recent price action shows that the rise, and subsequent retracement in VIX prices, has occurred gradually. That would seem to indicate that worry among investors is gradually strengthening, and with the VIX still holding a price level near 20, it may not have hit its ultimate peak just yet.
3/
Momentum Precedes Price
To provide a little optimism to those bullish investors who may feel as though they are currently clinging to a market cliff by no more than their fingernails, I’d like to introduce a concept championed in the 1950s by market analyst and author George C. Lane. He is the inventor of the popular Stochastic oscillator commonly used by technical analysts and traders.
The indicator today is better known than the idea Lane had for creating it in the first place–which is a pity since this idea is actually rather novel and well developed. Lane believed that “Momentum precedes price.” It was more commonly assumed in Lane’s day (and perhaps still is) that volume precedes price, however he rejected that notion. He built the Stochastic oscillator to track momentum.
To capture the essence of Lane’s idea, I have added a 14-day Donchian channel indicator to the price chart and placed the 14-day Stochastic oscillator below (orange line).
It takes a hot second to train your eye to see what Lane was driving at, but the small red and green arrows mark the points where momentum showed a shift. These are fair trading signals, and while not infallible, can provide excellent information for a trader who can read them in real time.
The current chart shows that we may be observing a momentum shift from bearish to bullish price action right now. Those investors who have piled in and doubled down for the next upward move can only hope that Lane knew what he was talking about.
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Originally posted 24th March 2025
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