New Highs Amid Shutdown Uncertainty
While a market rally persists, underlying issues—both technical and macroeconomic—are surfacing. The macro environment, specifically, has revealed a profound contradiction: a simultaneous combination of a soft jobs market, weakening service sector activity, and persistent inflationary pressure.
This precarious macroeconomic setup has fueled market optimism. The ongoing US government shutdown has caused a “data blackout,” preventing the release of critical official indicators like the monthly jobs report. In the absence of this data, markets are heavily relying on private-sector reports, such as the ADP’s finding that the private sector shed 32,000 jobs in September. This soft labor reading has bolstered investor confidence in an imminent Federal Reserve rate cut this month.
However, a closer look at the available data reveals a more concerning picture. The ISM Services Index has dropped sharply to the 50% breakeven threshold, with the critical business activity component slipping into contractionary territory for the first time since May 2020. This weakness in the two-thirds of the U.S. economy is compounded by stubbornly high “prices paid” (69.4%), signaling that sticky inflation remains embedded within the service sector. This leaves the Fed in the challenging position of “flying blind” and facing a scenario of weakening economic activity coupled with elevated price pressures.
Throughout the week, headlines repeatedly included expressions like, “investors shake off government shutdown.” Tops are a process, and this media narrative reminded me of the initial days of COVID news when the market briefly continued its climb. While a government shutdown can’t be compared to a pandemic, human behavior is cyclical. Now, the technical warnings have finally consolidated, aligning perfectly with the macroeconomic conditions that investors are “shaking off”.
Today, our focus shifts to the technical signals pointing toward an overheated market that is highly likely to trigger a pullback, one of them is related to the volatility index $Cboe Volatility Index(VIX)$ :
The recent price action, where the S&P 500 $S&P 500(.SPX)$ moved higher over the last five days even as the VIX rose, historically signals a high probability of a subsequent stock market pullback. While the initial outlook for the next week has only a 50% chance of the SPX closing positive, the risk profile significantly deteriorates thereafter. The probability of the SPX closing in the green two or three weeks later drops sharply, below 10% for the third week. This historical pattern alone suggests the confluence of a rising SPX and VIX typically resolves with a downward move over the following three weeks.
That’s not all, in the chart below for the VIX you will see a technical indicator suggesting a breakout, during the last weeks we have been tracking it, today the signal looks imminent and difficult to invalidate.
The VIX, or CBOE Volatility Index, is often referred to as the market’s “fear gauge” because it reflects investors’ collective expectation of volatility—the degree of price fluctuations—in the S&P 500 over the next 30 days. Understanding the VIX is essential for assessing market sentiment and managing risk.
Below 15: Low volatility, potentially indicating a complacent market.
15-30: Moderate volatility, considered a normal range with normal pullbacks.
Above 30: High volatility, suggesting investor fear and potential for larger price swings or corrections in the stock market.
Above 40: Very high volatility, often associated with significant market crashes or bear markets.
Based on a VIX of 30, the market might be anticipating a monthly volatility of around 8.66% for the S&P 500. Currently, with the VIX close to 17, the equivalent anticipated monthly volatility for the S&P 500 is approximately 4.91%.
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