The Volatility Index is Sending Mixed Signals

Last week's action was certainly celebratory, and as of this morning, our Asset Allocation Model is sitting with this very bullish long-term posture.
 
 
This posture tells us that over the next 12 months the chance of having a positive gain in the S&P 500 is very high based on similar historic conditions.  As you are aware, however, as August was coming to an end, we cited that some of our shorter-term indicators turned more cautious.  We're still in that boat - long-term bullish, but on the shorter-term we suspect that this is not a great time to be making initial purchases.
 
The enthusiasm of last week's move does not change that stance.  On Friday we saw the volatility index drop down to 13.37.  This is a far cry from that super bullish condition we received in August 2011 when it soared above our magic level of 44.  Today, this denotes a low level of fear.  As with so many indicators, this gives a little bit of a mixed signal.  Just take a look at the chart below.
 
 
The bottom strip shows the action of the S&P 500.  You can see back in 1995 and 2004 that the initial penetration of today's level created some very strong gains in the next few years.  But since 2007, when it moved up above that level to stay, these drops in the VXO have signaled a stalling period (at best) in the next few weeks and months.
 
I guess you can see our logic for "sitting on the fence" here.  We're very bullish for the next 12 months, but for the short-term, we're willing to be on the sidelines with our aggressiveness. 
 
Don Hays
 
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