Stock trader complacency setting in, judging by Vix

We looked for a muted Santa rally this year, we got it. It’s important to note that while the media considers a Santa rally to come the week of Christmas, in reality the timing of it is supposed to be the beginning of December and should last at least thru the period where traders take their year-end vacation.

This year it came in one fell swoop and we’ve been retracing it ever since. We had strong starts from biotech and steel stocks and they have mostly faded. The sector that is still working is drug stocks. Apple computer backed off which was a key consideration of why tech backed off last week.

My biggest concern of the week (which is last week’s news) really has been what the Chinese Premier said regarding they have inflation under control. The SSE voted last week and may have finally found a low. However it outright rejected the bigger 261 day window last week. My next biggest concern and as far as markets go this is the most important technical news heading into the new week. We have a VIX trading in the 20’s after the market had a couple of really tough days. That means traders are complacent with where we are in the bigger scheme of things. I understand it’s based on a lower volume holiday seasonal type trading agenda. Still, when the market trades lower and the VIX doesn’t spike you have to be concerned about it. The condition is not likely to materially change between now and the New Year so January might be more bearish. We hear on television that it’s actually a good thing as traders are anticipating less volatility. Nothing could be further from the truth. Since when do traders get what they want from the stock market? The stock market is not the take-out counter. In recent bottoms the VIX was sitting in the mid 30’s and for us to get there it would require several big distribution days and I don’t really think you can have the volume the rest of this year to accomplish it.

This is a good time to explain what fuels trouble in the market. You’ll recall earlier in the year when markets were topping how news represented the prevailing psychology. First we had the soft patch in the February to May sequence. I’m still trying to figure out what a soft patch really is. After the soft patch sequence Bob Pisani reported from a big hedge fund conference that the big players were looking at a ‘see-over’ trade. Do you remember that? Simply put, by June and into July when the NDX finally topped hedge fund managers were looking beyond the soft patch to the 4th quarter when they anticipated that GDP would be rolling again. It’s this kind of complacency that gets us in trouble. Bear markets will extend to the point the complacency is washed out of the system and fear levels rise like they did in March, August and October. That’s why it’s really tough for perma-bears to tell us they expect the 2009 lows to be taken out. There is absolutely no way to predict it. Why? Simply put, it’s absolutely impossible to predict where complacency or fear is going to show up. As you know when we got to the black swan debt ceiling spectacle there was no more talk of soft patches. Now we are starting to get the 1929 comparisons.

How can we reverse the current situation? If markets can drop on complacency they can certainly rise on fear and worry. That’s called a wall of worry. It’s also impossible to predict but if a market suddenly rises and the VIX doesn’t drop then we can turn more bullish.

Gold got hit and that’s really the next biggest story of the week. This is purely an inflation/deflation play. Gold dropping along with oil is suggesting that deflation is once again rearing its ugly head. As long as the Greenback doesn’t break free from the levels of last week’s high it’s not a problem yet. But we are coming to the point where it can become a problem. I’ve been telling you for nearly 3 years that as long as the Dollar is kept in check in the larger trading range conditions in the recovery can stay in motion. Now we are halfway up the range. Because conditions are fragile with Europe we still have a buffer in the low 80s’ but who really wants to see it cut so close? I think that if the Dollar gets above the approximate 85 level you can see some serious fear levels in the stock market. Based on what we’ve discussed here that can’t be a prediction but really a hypothesis. If the Dollar goes to 85 and the VIX would continue to drop I think we would be in big trouble.

Next page: Where might gold go?

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