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3 Ways to Detect a Fiscal Cliff Disaster

These 3 indicators will show you whether it's time for a risk-on or risk-off approach


We think it is fairly safe to say that many investors feel like they are lost in the fiscal cliff wilderness right now as Congress continues to argue about how much revenue to raise and how much spending to cut to be able to come to an agreement. If things weren’t already complicated enough, the United States is also about to reach its debt ceiling once again, and we all remember what a pleasant fight experience that was last time.

So where do we go from here? The honest answer is…nobody knows for sure. However, we can look for recognizable landmarks to help us know where the Wall Street herd is moving – which will tell us how we need to position our portfolios.

Landmark #1: S&P 500 Below 1,400

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The first landmark we all need to be watching for is a breach below 1,400 on the S&P 500. As you can see in Figure 1, we first breached this landmark on Nov. 7 after the Presidential election. However, the market has been able to rebound and claw its way back above 1,400 since that time.

If the S&P 500 were to drop below this level again, it would be a clear sign that investors are selling, taking their profits off the table and hunkering down for what comes next.

Landmark #2: VIX Above 19.5

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The second landmark we need to be on the lookout for is the CBOE Volatility Index (CBOE:VIX) to climb above 19.5. As you can see in Figure 2, the VIX hasn’t closed above 19.5 since July 24. It tried to rally above this level on Oct. 23 and Nov. 7 – the same day the S&P 500 broke below 1,400 – but it has not been able to sustain a rally of fear long enough.

The S&P 500 will most likely drop below 1,400 before the VIX is able to rise above 19.5, but seeing the VIX do so would be added confirmation that the market is headed for lower lows.

Landmark #3: 10-Year Treasury Yields Below 1.55%

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The last landmark we need to be on the lookout for is 10-year Treasury yields dropping below 1.55%. As you can see in Figure 3, the 10-year yield hasn’t closed below 1.55% since Aug. 2, but it is getting quite close to doing so again.

NOTE: To derive the yield of the 10-year Treasury from the CBOE 10-year Treasury Yield Index, you simply divide the number on the chart by 10 – or shift the decimal one place to the left. For instance, the current reading of 15.75 indicates a yield of 1.575%.

Seeing the yield on the 10-year Treasury drop below 1.55% would tell us that investors are moving their money from stocks to bonds and have shifted from a “risk on” mindset to a “risk off” mindset and are looking to preserve their investing capital rather than earn a healthy return on it.

CAVEAT: There is one caveat to this landmark. The Federal Open Market Committee (FOMC) is meeting again next week and will be releasing a statement on Wednesday, Dec. 12. If the FOMC were to come out with QE4, stating that the Fed will look to offset the $45 billion per month that is currently being spent as part of “Operation Twist” but is set to expire at the end of this year with a new round of easing starting in January 2013, we could see Treasury yields fall at the same time stocks begin to rise on news of new stimulus.

Article printed from InvestorPlace Media,

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