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Reading the Signs

Mike Zaccardi  |  July 14, 2020

I MISS BASEBALL. I love the strategy and the moments of excitement that come in the later innings. I also like to attend games, watching the interaction among the players and coaches. The third base coach plays a big role, relaying signals from the manager to the baserunners and the batter. If you’re a player, and you miss a signal, it can ruin the next play.

While the stock market has signals, they aren’t as black and white as those in baseball. But they’re still important. While I’m mostly a buy-and-hold investor, I follow the markets closely, keeping an eye on trends and market signals.

I truly have a passion for both fundamental and technical analysis, and I believe both have value. Indeed, providing insights to traders and investors is a key part of my day job. I even teach this stuff to college finance students, and I have nothing against those who actively manage their portfolio and pick stocks.

In fact, we all make active investment decisions, even if we aren’t choosing individual stocks and bonds. Should we overweight small caps? U.S. shares? Value stocks? Those are active decisions. Even index-fund investors make active decisions left and right.

Indeed, it’s hard to be a truly passive investor. I don’t claim to be. While I mainly stick to index funds in tax-advantaged accounts, there are indicators I monitor to get a handle on the market. What do I look at? Here are the five financial indicators I find especially useful:

1. The dollar. What happens in the currency markets affects everything. I keep tabs on the U.S. dollar index, which compares the value of the greenback to a basket of other currencies—mainly the euro, yen and pound.

If the U.S. dollar is trending up, it usually means commodities and energy stocks are underperforming. Those lower commodity prices are a plus for many U.S. corporations, which see their costs fall. The upshot: A slow and steady rise in the dollar is typically a positive economic sign.

But if the dollar rises sharply, that’s not so good—and often it’s an indicator of nervous market sentiment. Think about 2008 or the height of the market crisis this past March. During such times of panic, investors often flock to the safety of the dollar.

2. The VIX. Be warned: When the VIX is elevated, the market is going to move—a lot. What’s the VIX? It’s a measure of expected volatility in the S&P 500 over the next 30 days, based on prices in the options market.

A VIX reading of 80 means the expected daily move will be 5%, or about 1,300 points on the Dow, which is what we saw back in March. From a psychological point of view, expect the stock market’s moves to be hard to stomach. By contrast, a VIX of 12—which is what we saw in December and January—means the daily move is a more soothing 0.8% per trading day, with many sessions finishing pretty much unchanged.

3. Energy stocks vs. oil prices. Are energy stocks rallying in the face of falling oil prices? That’s precisely what the market witnessed during late March and much of April. Trading in energy company stocks tends to be forward looking, while the commodities are more in-the-moment. When oil stocks are heading higher in the face of lower energy prices, that’s a bullish signal to me—and the opposite is true as well.

4. News and the reaction to it. This trips up a lot of investors. Take the current situation: The economy is in a shambles and yet the S&P 500 has rallied strongly in recent months. Focusing simply on the latest news and economic headlines can lead you astray.

Instead, you need to follow both the news and the market’s reaction. When stocks go up on bad news, it tends to be bullish. When strong data is released and the market sells off, that’s a bearish sign. What’s the best buy signal? When you’re scared to flip on the financial news, it’s probably a good time to purchase stocks.

5. My brother’s friend. When I hear that family members and their friends are getting the itch to trade stocks on Robinhood, I get nervous about where the market may be headed. Are you seeing such naïve enthusiasm? It’s often a contrarian indicator.

Mike Zaccardi is a portfolio manager at an energy trading firm and a finance instructor at the University of North Florida. He also works as a consultant to financial advisors on an hourly basis, helping with portfolio analysis and financial planning. Mike is a Chartered Financial Analyst and Chartered Market Technician, and has passed the coursework for the Certified Financial Planner program. His previous articles include Inflection Point, Getting Back In and Riding the Bear. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn and email him at MikeCZaccardi@gmail.com.

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