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Is a Correction Lurking in the Not-Too-Distant Future?

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After all of the forthcoming analysis and discussion in the weeks ahead, price action will continue to remain a mystery until the debt ceiling situation is behind us.

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The great market prognosticators have by now came out with their 2013 predictions about financial markets. It seems to me to be a fool's game to try to predict what financial markets are going to do in the future.

I want to be clear in stating that I do not know what is going to happen in the future. I do not know where the S&P 500 Index (INDEXSP:.INX) is going to trade tomorrow, let alone six months from now. Most market pundits simply will not admit this fact.

These same market pundits seemingly are unable to be honest about their own fallibility. In their minds, they believe it undermines their credibility or will hurt their forward sales for some book or strategy they are going to unveil. I, for one, do not prescribe to that notion; I believe in telling the truth.

The truth is that these so-called market experts do not know any more than you or I about price action in the distant future. However, what I do know is that forward price action remains a mystery until its unveiled in the present.

Instead of wasting time discussing potential price action in the future, why not focus on a few pieces of information that have occurred and are known facts right now. I think the chart below points out that in the intermediate time frame, equity indexes are reaching extreme overbought conditions.



As seen above, the number of stocks trading above their 50-day moving averages is reaching close to the highest levels in the past five years. Many times when these price levels have been reached, we witness a correction at the very least and any short-term gains are usually given back in short order. This is not to say that prices are going to sell off tomorrow or in the next few weeks; however, it is a warning that a correction is likely lurking in the not-so-distant future.

To help confirm this notion, a quick look at the Volatility Index (^VIX) demonstrates just how much complacency there is in the short-term spot VIX price, which is currently trading below five-year lows. When the VIX moves lower, the outcome is typically bullish for the S&P 500 Index; when the VIX moves higher, the reaction is typically bearish in terms of the S&P 500 Index.



As seen above, the VIX is trading near the bottom of its recent range. This helps confirm the strength we have seen the past few weeks; however, a reversal seems likely in the near future. Should the VIX pick up considerably, it would have a negative impact on the S&P 500 Index. Furthermore, if we go out several months in time, the Volatility Index Term Structure steepens wildly.
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No positions in stocks mentioned.
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