I am cautious because I do not understand. Every time I do not understand, I force myself to think outside my 'box'. My recent market posts have expressed this cautiousness because of VIX/SP500 overlay which shows a rally low for the VIX. Despite my die-hard market bull thesis, the technical set up has historically merited caution, and for the most part, the caution is vindicated.
My dilemma is with properly interpreting the current action, along with mouth watering valuations of certain stocks. Here in lies the contradiction, hence the dilemma.
The VIX is approaching levels not seen since the 2002-2007 rally.
The Vix is a fairly complicated ratio of call/put SP500 options, but a ratio none-the-less. Prior to 2002 the Vix has historically bounced off the current level (around 16 as the low) and low 30s as the high. Since it is a ratio, the pattern should remain intact, unless there is an external force corrupting the equation. (ie extreme complacency as seen in 2002-2007)
At the moment, I do not know what could be corrupting the equation. The few things I can think of are:
1. The ECB debt activity for the PIGS
2. The Fed with QE2
3. Inexpensive market valuation
But these things have been going on for some time now, and has not altered the VIX dynamic before. So why should it now, especially when the Fed is going to stop QE2 in about a month? And while I would love to use the inexpensive market valuation thesis, the Vix did not deviate from its pattern even during the earnings rush of the 2000 tech bubble, so why should it matter now?
Basically, something is not jiving here, and until it starts to make sense to me, I will remain cautious. Which means I will be making very short-term trades, while I wait for solid entry points (as mentioned in previous posts). If individual stocks approach certain entry points, I will not hesitate to enter, but I will maintain a level of SPY Put protection if the VIX/SP500 condition persists.