WHAT THE CAPE/VIX RELATIONSHIP TELLS US IS LOOMING AHEAD
We were in the process of writing about the technical pattern in the VIX when we came across some research by Peter Schiff of Euro Pacific Capital illustrating the historical correlation of the CAPE/VIX Ratio to US Recessions go back to 1990. We have been warning about a unexpected US Recession scare coming in 2018.
A fairly reliable technical indicator is a megaphone topping pattern. We annotated Schiff's chart to more visibly reflect this.
If the possible message this chart is sending then we should soon see the VIX rise and the CAPE fall. Is this reflected in the VIX and CAPE technicals. Lets examine them!
VIX - AN ENDING DIAGONAL
An even more reliable pattern is "an ending diagonal" pattern, especially when it is multi year, shown here in red. The proprietary MATASII HPTZ (High Probability Trading Zones) show a rising cluster of them (concentric ellipses) above the ending diagonal.
The Green / Pink Pyramids at the bottom of the chart are MATASII Proprietary MACRO BIAS' based on independent Macro research - They have proven to a highly guide.
The large ending diagonal or contracting wedge can be seen starting on the left side of the chart (September 2015); the current market is coming in to the 'tip' of the pattern. Also note that an expanding wedge pattern may be starting to form: the last highs in Aug 2017 and April 2017 could be the top resistance. This would suggest that we may see volatility start to increase, with the range of movements spiking higher and higher on each new leg as the (potential) expanding wedge pattern develops. There is also a potential to see an extreme spike in volatility once the larger contracting wedge has broken.
Recent lows shown here on the daily have failed to reach the lower support of the larger contracting wedge (lowest blue support/resistance (s/r)), and have formed a potential bottom for a new pattern - expanding wedge. IF the current blue s/r is broken under we would be looking to the lowest blue s/r for support. IF the VIX continues to lift we would be watching for a break of the blue s/r from the contracting wedge (next blue s/r above market), and to see if it then makes a move towards the new expanding wedges resistance (next higher blue s/r from recent highs).
CAPE - THIRD HIGHEST LEVEL IN HISTORY
The Shiller Cyclically Adjusted PE (CAPE) at ~ 30 is no at the third highest level in the recorded history of the US stock market. Could it go higher - yes. What is the likelihood of this occurring -slight. What are the chances of the CAPE going lower when we see it fitting at the top end of a long term channel (shown in Red) - Extreme high!
I have found that long term success in the markets is predominately about risk mitigation through effective assessment of probabilities. The probability of these three charts aligning on a long term basis is such that ignoring what they are saying is not a prudent gamble.
Look for a US Recession entering the news headlines by mid 2018