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Jeff Saut: S&P 500, VIX Suggest Investors Have Become Too Complacent


Extreme levels of the S&P 500's P/E to VIX ratio have coincided with market bottoms and tops.

This article was originally posted on the Buzz & Banter where subscribers can follow over 30 professional traders as they share their ideas in real time. Want access to the Buzz plus unlimited market commentary? Click here to learn more about MVPRO+.

In 1978, Atlantic records released what would turn out to be Atlantic's best-selling record ever. The album was titled C'est Chic and was recorded by the singing group Chic. The hit tune from that album was "Le Freak," and it captured the number-one spot on the disco charts for seven weeks. Moreover, it ranked an amazing nineteenth on Billboard's "50th Anniversary All-Time Hot 100 Top Songs" chart.

Unsurprisingly, "Le Freak" was the song playing on Capitol Hill yesterday; at least that is what my friends there told me. The exact quote was, "We are pretty freaked out!" Of course, the "freakout" in question was House Majority Leader Eric Cantor's defeat by a "nobody" named David Brat. While this was a surprise, it is certainly in keeping with my theme that voters will elect smarter policymakers and therefore get smarter policies. Verily, I have been talking about that theme since Scott Walker withstood a recall vote in 2012. A change in the constituency of Congress -- what a novel idea -- but that is what happened yesterday; and it happened here in Florida when Alex Sink was beaten by another "nobody" named David Jolly.

Now, some of the media attribute those defeats to complacency, something that has come to Wall Street recently, as can be seen in the chart below:

Click to enlarge

This chart is constructed by dividing the S&P 500's (INDEXSP:.INX) P/E multiple by the Volatility Index (INDEXCBOE:VIX). Studying the chart shows how it targeted the lows in 2003, 2009, and 2011, as well as the highs in 2000 and 2007. Currently, it is suggesting there is just too much complacency by investors. When taken in concert with the McClellan Oscillator (which is sending an overbought signal), the lack of any internal energy from my proprietary indicators (it should take a few weeks to rebuild that energy), the drop in the Buying Power Index, and now the 14-day Stochastic falling below its moving average, "In the near term, at least by my work, the upside is going to be very difficult," as I wrote, on Monday. There is some support for the S&P 500 between 1930 and 1940, but the real test should occur at 1920, which would be a 38.2% retracement of the recent rally. If the S&P falls decisively through 1920, the odds will increase that the market has become more vulnerable to the 10% to 12% pullback that history says is due sometime this year. Longer term, I remain bullish given the S&P's 6%+ earnings yield.
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No positions in stocks mentioned.
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