On January 12, Haiti was devastated by a powerful earthquake.  Eight days later on January 20, the country was dealt another blow by an aftershock that registered 5.9. Additional destruction occurred and more people were injured. According to news accounts, the temblor was the largest of more than 50 significant aftershocks so far. One expert was quoted as saying that aftershocks can die out quickly or they can continue for weeks and months.

A year ago, the U.S. financial markets were suffering from a massive economic disaster—described frequently as the worst since the Great Depression of the 1930s. The recovery from that market meltdown began in March 2009. For several months afterward many investors and advisors—us included—were worried about another serious aftershock. Luckily so far there has not been a renewed downturn and major indices have staged an impressive rally. That does not mean all the danger is past. The market downturn January 20-22 could be compared to an aftershock from an earthquake.

In fact, during much of 2009 our technical indicators were showing that high levels of market risk remained, even though a rally was underway.

The chart below is a good example. I have previously written about the VIX, an investment instrument called the Volatility Index and also nicknamed the Fear Index. VIX is a measure of market volatility. The value of VIX rises when market volatility increases. Some investors and advisors use VIX as a hedge to protect other investments against downturns.

The chart covers the previous five years. I added a blue line to the chart to identify a level that historically coincides with high levels of market risk. You can see that the VIX began to trend above that level in the latter stages of 2007—about the same time that major market indices began the most recent bear market.

It has only been in the past month or so that VIX has again fallen below the high-risk level. But that might not last, because this week has seen an increase in market volatility.

For months we have warned that although the market was rising, many of our indicators showed that risk remained above acceptable levels. Today that is still largely true. Although we have dabbled in a few small positions, most of our assets remain in cash. The past few trading sessions lend justification to such a position.

Thursday saw the Dow drop by more than 200 points. Many investors and traders remain worried about unemployment, the prospect of rising inflation and interest rates, ongoing weakness in the realty market, etc.

In recent weeks I’ve heard from a number of acquaintances who are bragging about how much money they made in the stock market in recent weeks. Usually I hear those kinds of comments near market tops. While that is certainly not a supportable indicator for what the stock market is likely to do next, there are many other technical indicators like the VIX warning that investors still need to exercise caution. Additional aftershocks in the financial markets remain a strong possibility.
F.S.