Volatility Warning: Correction Ahead?

05/04/2017 2:45 am EST

Focus: STOCKS

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

We continue to watch for a break below the S&P 500’s March low of 2,320 to signal that a larger correction is underway, cautions Elliott Gue, editor of Capitalist Times.

The index remains overdue for a 5 to 10 percent correction, especially with the market approach a period of seasonal weakness that lasts from May to September.

Several catalysts could trigger a pullback, including uncertainty about the timing of US tax cuts, geopolitical risk in Syria and North Korea, and upcoming elections in France, the UK and Germany.

The Chicago Board Options Exchange S&P 500 Volatility Index (VIX) measures the choppiness in the stock market based on the weighted average of implied volatilities for a wide range of options.

The spread between near-month VIX futures and longer-dated contracts can provide insight into expectations for volatility. When front-month contracts trade at a premium to longer-dated ones, this scenario can signal that the market has started to price in increased volatility and a potential correction.

The June VIX futures contract trades at a 0.06-point premium to the May contract; this spread dropped to near or below zero in late 2015 (early stages of a 10 percent selloff in the S&P 500), mid-June 2016 (6 percent correction) and mid-October 2016 (4 percent decline).

With the S&P 500 is trading only 2.4 percent off its all-time high, this indicator suggests additional downside could be on the way.

What should be on your shopping list in the event of a pullback? The financial sector remains at the top of our shopping list.

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